Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2013.
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission file number: 333-173105
AFFINION GROUP HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware | 16-1732155 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
6 High Ridge Park
Stamford, CT 06905
(Address, including zip code, of principal executive offices)
(203) 956-1000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the registrant’s common stock, $0.01 par value, as of April 24, 2013 was 84,913,377
Table of Contents
Page | ||||
Item 1. | 1 | |||
1 | ||||
Unaudited Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012 | 1 | |||
2 | ||||
3 | ||||
4 | ||||
Notes to Unaudited Condensed Consolidated Financial Statements | 6 | |||
Item 2. | ||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 24 | |||
Item 3. | ||||
39 | ||||
Item 4. | ||||
40 | ||||
42 | ||||
Item 1. | ||||
42 | ||||
Item 1A. | ||||
42 | ||||
Item 2. | ||||
Unregistered Sales of Equity in Securities and Use of Proceeds | 42 | |||
Item 3. | ||||
42 | ||||
Item 4. | ||||
42 | ||||
Item 5. | ||||
42 | ||||
Item 6. | ||||
42 | ||||
S-1 |
i
Table of Contents
Item 1. | Financial Statements |
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2013 AND DECEMBER 31, 2012
(In millions, except share amounts)
March 31, 2013 | December 31, 2012 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 82.5 | $ | 51.9 | ||||
Restricted cash | 34.3 | 34.4 | ||||||
Receivables (net of allowance for doubtful accounts of $11.1 and $9.4, respectively) | 147.1 | 140.1 | ||||||
Profit-sharing receivables from insurance carriers | 82.6 | 74.6 | ||||||
Prepaid commissions | 37.5 | 42.5 | ||||||
Income taxes receivable | 2.9 | 6.3 | ||||||
Other current assets | 81.8 | 85.0 | ||||||
|
|
|
| |||||
Total current assets | 468.7 | 434.8 | ||||||
Property and equipment, net | 129.8 | 136.5 | ||||||
Contract rights and list fees, net | 21.5 | 22.0 | ||||||
Goodwill | 601.9 | 607.3 | ||||||
Other intangibles, net | 206.2 | 225.2 | ||||||
Other non-current assets | 61.7 | 70.8 | ||||||
|
|
|
| |||||
Total assets | $ | 1,489.8 | $ | 1,496.6 | ||||
|
|
|
| |||||
Liabilities and Deficit | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 11.7 | $ | 11.8 | ||||
Accounts payable and accrued expenses | 434.5 | 411.3 | ||||||
Payables to related parties | — | 0.1 | ||||||
Deferred revenue | 112.1 | 114.6 | ||||||
Income taxes payable | 6.9 | 8.9 | ||||||
|
|
|
| |||||
Total current liabilities | 565.2 | 546.7 | ||||||
Long-term debt | 2,231.8 | 2,234.2 | ||||||
Deferred income taxes | 67.6 | 71.9 | ||||||
Deferred revenue | 12.7 | 15.3 | ||||||
Other long-term liabilities | 40.3 | 41.0 | ||||||
|
|
|
| |||||
Total liabilities | 2,917.6 | 2,909.1 | ||||||
|
|
|
| |||||
Commitments and contingencies (Note 7) | ||||||||
Deficit | ||||||||
Common stock, $0.01 par value, 360,000,000 shares authorized, 85,129,464 and 85,128,062 shares issued and 84,913,377 and 84,912,610 shares outstanding | 0.9 | 0.9 | ||||||
Additional paid-in capital | 133.9 | 132.9 | ||||||
Accumulated deficit | (1,567.8 | ) | (1,553.3 | ) | ||||
Accumulated other comprehensive income | 4.9 | 6.5 | ||||||
Treasury stock, at cost 216,087 shares and 215,452 shares | (1.1 | ) | (1.1 | ) | ||||
|
|
|
| |||||
Total Affinion Group Holdings, Inc. deficit | (1,429.2 | ) | (1,414.1 | ) | ||||
Non-controlling interest in subsidiary | 1.4 | 1.6 | ||||||
|
|
|
| |||||
Total deficit | (1,427.8 | ) | (1,412.5 | ) | ||||
|
|
|
| |||||
Total liabilities and deficit | $ | 1,489.8 | $ | 1,496.6 | ||||
|
|
|
|
See accompanying notes to the unaudited condensed consolidated financial statements.
1
Table of Contents
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012
(In millions)
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
Net revenues | $ | 347.4 | $ | 381.8 | ||||
|
|
|
| |||||
Expenses: | ||||||||
Cost of revenues, exclusive of depreciation and amortization shown separately below: | ||||||||
Marketing and commissions | 117.7 | 154.8 | ||||||
Operating costs | 116.2 | 118.1 | ||||||
General and administrative | 42.2 | 22.1 | ||||||
Depreciation and amortization | 29.6 | 50.1 | ||||||
|
|
|
| |||||
Total expenses | 305.7 | 345.1 | ||||||
|
|
|
| |||||
Income from operations | 41.7 | 36.7 | ||||||
Interest income | 0.1 | 0.3 | ||||||
Interest expense | (51.4 | ) | (47.6 | ) | ||||
Other income, net | 0.1 | 0.1 | ||||||
|
|
|
| |||||
Loss before income taxes and non-controlling interest | (9.5 | ) | (10.5 | ) | ||||
Income tax expense | (5.1 | ) | (2.7 | ) | ||||
|
|
|
| |||||
Net loss | (14.6 | ) | (13.2 | ) | ||||
Less: net loss (income) attributable to non-controlling interest | 0.1 | (0.2 | ) | |||||
|
|
|
| |||||
Net loss attributable to Affinion Group Holdings, Inc. | $ | (14.5 | ) | $ | (13.4 | ) | ||
|
|
|
| |||||
Net loss | $ | (14.6 | ) | $ | (13.2 | ) | ||
Currency translation adjustment, net of tax | (1.7 | ) | 2.3 | |||||
|
|
|
| |||||
Comprehensive loss | (16.3 | ) | (10.9 | ) | ||||
Less: comprehensive loss (income) attributable to non-controlling interest | 0.2 | (0.2 | ) | |||||
|
|
|
| |||||
Comprehensive loss attributable to Affinion Group Holdings, Inc. | $ | (16.1 | ) | $ | (11.1 | ) | ||
|
|
|
|
See accompanying notes to the unaudited condensed consolidated financial statements.
2
Table of Contents
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN DEFICIT
FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND YEAR ENDED DECEMBER 31, 2012
(In millions)
Affinion Group Holdings, Inc. Deficit | ||||||||||||||||||||||||
Common Stock and Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Non- Controlling Interest | Total Deficit | |||||||||||||||||||
Balance, January 1, 2013 | $ | 133.8 | $ | (1,553.3 | ) | $ | 6.5 | $ | (1.1 | ) | $ | 1.6 | $ | (1,412.5 | ) | |||||||||
Net loss | (14.5 | ) | (0.1 | ) | (14.6 | ) | ||||||||||||||||||
Currency translation adjustment, net of tax | (1.6 | ) | (0.1 | ) | (1.7 | ) | ||||||||||||||||||
Share-based compensation | 1.0 | 1.0 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Balance, March 31, 2013 | $ | 134.8 | $ | (1,567.8 | ) | $ | 4.9 | $ | (1.1 | ) | $ | 1.4 | $ | (1,427.8 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Affinion Group Holdings, Inc. Deficit | ||||||||||||||||||||||||||||
Common Stock and Additional Paid-in Capital | Warrants | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Non- Controlling Interest | Total Deficit | ||||||||||||||||||||||
Balance, January 1, 2012 | $ | 126.8 | $ | 1.7 | $ | (1,413.7 | ) | $ | 5.2 | $ | (1.1 | ) | $ | 1.0 | $ | (1,280.1 | ) | |||||||||||
Net loss | (139.6 | ) | 0.7 | (138.9 | ) | |||||||||||||||||||||||
Currency translation adjustment, net of tax | 1.3 | (0.1 | ) | 1.2 | ||||||||||||||||||||||||
Issuance of common stock related to restricted stock units and options | 0.1 | 0.1 | ||||||||||||||||||||||||||
Share-based compensation | 5.2 | 5.2 | ||||||||||||||||||||||||||
Expiration of warrants | 1.7 | (1.7 | ) | — | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||
Balance, December 31, 2012 | $ | 133.8 | $ | — | $ | (1,553.3 | ) | $ | 6.5 | $ | (1.1 | ) | $ | 1.6 | $ | (1,412.5 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to the unaudited condensed consolidated financial statements.
3
Table of Contents
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND 2012
(In millions)
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
Operating Activities | ||||||||
Net loss | $ | (14.6 | ) | $ | (13.2 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 29.6 | 50.1 | ||||||
Amortization of debt discount and financing costs | 3.1 | 2.7 | ||||||
Unrealized loss on interest rate swaps | — | 0.9 | ||||||
Adjustment to liability for additional consideration based on earn-out | — | (14.6 | ) | |||||
Share-based compensation | 2.5 | 3.1 | ||||||
Deferred income taxes | 3.3 | 1.0 | ||||||
Net change in assets and liabilities: | ||||||||
Restricted cash | (0.3 | ) | 0.3 | |||||
Receivables | (9.9 | ) | (21.5 | ) | ||||
Receivables from related parties | — | 0.7 | ||||||
Profit-sharing receivables from insurance carriers | (8.0 | ) | (14.5 | ) | ||||
Prepaid commissions | 4.6 | 3.1 | ||||||
Other current assets | 1.2 | (4.5 | ) | |||||
Contract rights and list fees | 0.4 | (0.2 | ) | |||||
Other non-current assets | 0.1 | 0.1 | ||||||
Accounts payable and accrued expenses | 31.4 | 42.1 | ||||||
Payables to related parties | (0.1 | ) | (0.6 | ) | ||||
Deferred revenue | (3.0 | ) | (5.1 | ) | ||||
Income taxes receivable and payable | 1.4 | 0.5 | ||||||
Other long-term liabilities | (0.7 | ) | (1.2 | ) | ||||
Other, net | 3.6 | (0.7 | ) | |||||
|
|
|
| |||||
Net cash provided by operating activities | 44.6 | 28.5 | ||||||
|
|
|
| |||||
Investing Activities | ||||||||
Capital expenditures | (8.8 | ) | (14.7 | ) | ||||
Restricted cash | (0.1 | ) | 0.1 | |||||
Acquisition-related payments, net of cash acquired | (0.9 | ) | (1.2 | ) | ||||
|
|
|
| |||||
Net cash used in investing activities | (9.8 | ) | (15.8 | ) | ||||
|
|
|
| |||||
Financing Activities | ||||||||
Principal payments on borrowings | (3.0 | ) | (2.9 | ) | ||||
|
|
|
| |||||
Net cash used in financing activities | (3.0 | ) | (2.9 | ) | ||||
|
|
|
|
4
Table of Contents
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
Effect of changes in exchange rates on cash and cash equivalents | (1.2 | ) | 0.8 | |||||
|
|
|
| |||||
Net increase in cash and cash equivalents | 30.6 | 10.6 | ||||||
Cash and cash equivalents, beginning of period | 51.9 | 106.4 | ||||||
|
|
|
| |||||
Cash and cash equivalents, end of period | $ | 82.5 | $ | 117.0 | ||||
|
|
|
| |||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Interest payments | $ | 17.4 | $ | 17.9 | ||||
|
|
|
| |||||
Income tax payments, net of refunds | $ | 0.4 | $ | 1.0 | ||||
|
|
|
| |||||
Non-cash investing and financing activities: | ||||||||
Accrued capital expenditures | $ | 0.2 | $ | 1.1 | ||||
|
|
|
|
See accompanying notes to the unaudited condensed consolidated financial statements.
5
Table of Contents
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unless otherwise noted, all dollar amounts are in millions, except per share amounts)
1. | BASIS OF PRESENTATION AND BUSINESS DESCRIPTION |
Basis of Presentation—On October 17, 2005, Cendant Corporation (“Cendant”) completed the sale of the Cendant Marketing Services Division (the “Predecessor”) to Affinion Group, Inc. (“Affinion”), a wholly-owned subsidiary of Affinion Group Holdings, Inc. (the “Company” or “Affinion Holdings”) and an affiliate of Apollo Global Management, LLC (“Apollo”), pursuant to a purchase agreement dated July 26, 2005 for approximately $1.8 billion (the “Apollo Transactions”).
All references to Cendant refer to Cendant Corporation, which changed its name to Avis Budget Group, Inc. in August 2006, and its consolidated subsidiaries, specifically in the context of its business and operations prior to, and in connection with, the Company’s separation from Cendant.
The accompanying unaudited condensed consolidated financial statements include the accounts and transactions of the Company. In presenting these unaudited condensed consolidated financial statements, management makes estimates and assumptions that affect reported amounts of assets and liabilities and related disclosures, and disclosure of contingent assets and liabilities, at the date of the financial statements, and reported amounts of revenues and expenses during the reporting periods. Estimates, by their nature, are based on judgments and available information at the time such estimate is made. As such, actual results could differ from those estimates. In management’s opinion, the unaudited condensed consolidated financial statements contain all normal recurring adjustments necessary for a fair presentation of interim results reported. The results of operations reported for interim periods are not necessarily indicative of the results of operations for the entire year or any subsequent interim period.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and following the guidance of Rule 10-01 of Regulation S-X for interim financial statements required to be filed with the U.S. Securities and Exchange Commission (the “SEC”). As permitted under such rules, certain notes and other financial information normally required by accounting principles generally accepted in the United States of America have been condensed or omitted; however, the unaudited condensed consolidated financial statements do include such notes and financial information sufficient so as to make the interim information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes of the Company as of December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on February 28, 2013 (the “Form 10-K”).
Business Description— The Company is a global leader in the designing, marketing and servicing of comprehensive customer engagement and loyalty solutions that enhance and extend the relationship of millions of consumers with many of the largest and most respected companies in the world. Generally, the Company partners with these leading companies in two ways: 1) by developing and marketing programs that provide valuable services to their end-customers, and 2) by providing the back-end technological support and redemption services for points-based loyalty programs. The Company refers to the companies that it works with to provide customer engagement and loyalty solutions as its marketing partners. The Company refers to the consumers with whom it provides services directly under a contractual relationship as subscribers or members. The Company refers to those consumers that it services on behalf of a third party, such as one of its marketing partners, and with whom it has a contractual relationship as end-customers.
The Company utilizes its expertise in a variety of direct engagement media to market valuable products and services to the customers of its marketing partners on a highly targeted campaign basis. The selection of the media employed in a campaign corresponds to the preferences and expectations the targeted customers have demonstrated for transacting with the Company’s marketing partners, as the Company believes this optimizes response, thereby improving the efficiency of the Company’s marketing investment. Accordingly, the Company maintains significant capabilities to market through direct mail, point-of-sale, direct response television and internet, inbound and outbound telephony and voice response unit marketing, as well as other media as needed.
The Company designs customer engagement and loyalty solutions with a suite of benefits that it believes are likely to interest and engage consumers based on their needs and interests, with a particular focus on programs offering lifestyle and protection benefits and programs which offer savings in purchasing everyday items. For example, the Company provides discount travel services, credit monitoring and identity-theft resolution, accidental death and dismemberment insurance (“AD&D”), roadside assistance, and various checking account and credit card enhancement services, as well as loyalty points redemptions for goods and merchandise, as well as other products and services.
Affinion North America. Affinion North America is comprised of the Company’s Membership, Insurance and Package, and Loyalty customer engagement businesses in North America.
6
Table of Contents
• | Membership Products. The Company designs, implements and markets subscription programs that provide its members with personal protection benefits and value-added services including credit monitoring and identity-theft resolution services, as well as access to a variety of discounts and shop-at-home conveniences in such areas as concierge services, retail merchandise, travel, automotive and home improvement. |
• | Insurance and Package Products. The Company markets AD&D insurance and other insurance programs and designs and provides checking account enhancement programs to financial institutions. These programs allow financial institutions to bundle discounts, protection and other benefits with a standard checking account and offer these packages to customers for an additional monthly fee. |
• | Loyalty Products. The Company designs, implements and administers points-based loyalty programs for financial, travel, auto and other companies. The Company provides its clients with solutions that meet the most popular redemption options desired by their program points holders, including travel services, gift cards and merchandise. The Company also provides enhancement benefits to major financial institutions in connection with their credit and debit card programs. In addition, the Company provides and manages turnkey travel services that are sold on a private label basis to provide its clients’ customers with direct access to the Company’s proprietary travel platform. A marketing partner typically engages the Company on a fee-for-services contractual basis, where the Company generates revenue in connection with the volume of redemption transactions. |
• | Affinion International. Affinion International is comprised of the Company’s Membership, Package and Loyalty customer engagement businesses outside North America. The Company has not offered AD&D or related insurance outside North America since 2000. The Company expects to leverage its current international operational platform to expand its range of products and services, develop new marketing partner relationships in various industries and grow its geographical footprint. |
Recently Adopted Accounting Pronouncements
In July 2012, the FASB issued new guidance that amended previous guidance on testing indefinite-lived intangible assets, other than goodwill, for impairment. Under the new guidance, an entity testing an indefinite-lived intangible asset for impairment has the option of performing a qualitative assessment before calculating the fair value of the asset. It does not revise the requirements to test indefinite-lived intangible assets annually for impairment and between annual tests if there is a change in events or circumstances. The new guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The Company’s adoption of the new guidance did not have a material impact on its consolidated financial position, results of operations or cash flows.
In June 2011, the FASB issued new guidance that gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total for comprehensive income. The entity is also required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statements(s) where the components of net income and the components of other comprehensive income are presented. The guidance is to be applied retrospectively, for fiscal periods and interim periods within those years, beginning after December 15, 2011 and early adoption is permitted. In December 2011, the FASB issued new guidance deferring the changes in the June 2011 relating to presentation of classification adjustments. The Company elected to present the total of comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement of comprehensive income. The Company’s adoption of the new guidance, other than that related to presentation of reclassification adjustments, as of January 1, 2012 did not have a material impact on its consolidated financial position, results of operations and cash flows.
2. | ACQUISITIONS |
On November 14, 2012, the Company entered into, and consummated, a Share Sale and Purchase Agreement (“Agreement”) that resulted in the acquisition of Boyner Bireysel Urunler Satis ve Pazarlama A.S (“Back-Up”), a Turkish provider of assistance and consultancy services to its members, and a sister company, Bofis Turizm ve Ticaret A.S. (“Travel”), a Turkish travel agency. In accordance with the Agreement, on November 14, 2012, the Company acquired 90% of the outstanding capital stock of Back-Up and 99.99% of the outstanding capital stock of Travel for an upfront cash payment of approximately $12.5 million and contingent consideration payable ratably on each of the first three anniversaries of the acquisition date aggregating approximately $8.4 million. The Company also obtained a call option that grants the Company the ability to call the additional 10% of Back-Up’s capital stock for a nominal price no earlier than five years after the acquisition date and no later than eight years after the acquisition date. The Company also issued a put option to the former shareholders of Back-Up permitting the former shareholders to put the additional 10% of Back-Up capital stock to the Company under the same terms as the call option.
7
Table of Contents
Back-Up and Travel were owned by Turkey’s largest retail group and the Company believes that Back-Up’s and Travel’s assistance and concierge service model fits well with the Company’s global product offerings. The acquisition enables the Company to expand into Turkey, which the Company deems a key market, given both its size as well as the attractive demographics of its population, and enables the expansion of the Company’s product offerings to a new customer base.
The Company is in the process of finalizing its purchase price allocation for the acquisition of Back-Up and Travel. On a preliminary basis, the Company has allocated the purchase price of $19.0 million, consisting of the upfront cash payment of $12.5 million and the acquisition date fair value of the $8.4 million contingent consideration payable over three years, based on an income approach and probability model, at the present value of $6.5 million, among the assets acquired and liabilities assumed as follows (in millions):
Cash | $ | 2.3 | ||
Trade receivables | 4.0 | |||
Other current assets | 0.9 | |||
Property and equipment | 1.3 | |||
Intangible assets | 11.0 | |||
Goodwill | 6.8 | |||
Other assets | 0.1 | |||
Accounts payable and accrued liabilities | (6.6 | ) | ||
Other current liabilities | (0.5 | ) | ||
Deferred income taxes | (0.3 | ) | ||
|
| |||
Consideration transferred | $ | 19.0 | ||
|
|
The intangible assets are comprised principally of trade names ($5.1 million), which are being amortized on a straight-line basis over weighted average useful lives of ten years, and member relationships ($3.7 million), which are being depreciated on an accelerated basis over weighted-average useful lives of eight years. The goodwill, which is not expected to be deductible for income tax purposes, has been attributed to the International Products segment. Revenue and income (loss) from operations related to Back-Up and Travel included in the Company’s consolidated statement of comprehensive income for the three months ended March 31, 2013 is $2.7 million and $(1.8) million, respectively. In connection with the acquisition of Back-Up and Travel, the Company incurred $0.8 million of acquisition costs, of which $0.1 million has been included in general and administrative expense in the consolidated statement of comprehensive income for the three months ended March 31, 2013.
On July 14, 2011, the Company and Affinion Holdings entered into an Agreement and Plan of Merger to acquire Prospectiv Direct, Inc. (“Prospectiv”), an online performance marketer and operator of a daily deal website. On August 1, 2011, the merger was consummated and, as a result, the Company acquired all of the capital stock of Prospectiv for an initial cash purchase price of $31.8 million. If Prospectiv had achieved certain performance targets over the 30 month period that commenced on July 1, 2011, the former equity holders would have been entitled to additional consideration in the form of an earn-out of up to $45.0 million and certain members of Prospectiv’s management would have been entitled to receive additional compensation related to their continued employment of up to $10.0 million. Such additional consideration and compensation was to be settled in some combination of cash and shares of Affinion Holdings’ common stock. As of the acquisition date, the liability for the additional consideration to be paid in connection with the earn-out was estimated to be $24.1 million, which was recorded at its fair value at the acquisition date of $14.4 million. As of the acquisition date, the purchase price, consisting of the cash paid at closing and the estimated fair value of the earn-out as of the acquisition date, was estimated at $46.2 million. The Company has allocated the purchase price of $46.2 million among the assets acquired and liabilities assumed as follows (in millions):
Cash | $ | 2.4 | ||
Accounts receivable | 3.0 | |||
Other current assets | 0.5 | |||
Property and equipment | 0.5 | |||
Intangible assets | 12.3 | |||
Goodwill | 31.5 | |||
Accounts payable and accrued liabilities | (4.0 | ) | ||
|
| |||
Consideration transferred | $ | 46.2 | ||
|
|
8
Table of Contents
The intangible assets are comprised principally of trademarks and tradenames ($6.3 million), proprietary databases and systems ($2.8 million) and patents and technology ($2.5 million), which are being depreciated on a straight-line basis over weighted-average useful lives of ten, four and five years, respectively. The goodwill, which is not expected to be deductible for income tax purposes, has been allocated to the Membership Products segment.
In late March of 2012, Prospectiv implemented a reduction in force and revised its growth plans for 2012 and 2013. Based on these revised growth plans, the Company has concluded that it does not expect to pay any additional consideration in the form of an earn-out or additional compensation based on achievement of performance targets. Accordingly, during the three months ended March 31, 2012, the Company reversed certain accruals for additional considerationrecorded as part of the Prospectiv acquisition and additional compensation as the Company will not be able to achieve the growth originally planned for these years due to market conditions. The reduction of the accruals for additional consideration and additional compensation during the three months ended March 31, 2012 reduced general and administrative expense for the three months ended March 31, 2012 by $14.6 million and $1.1 million, respectively. In addition, during the three months ended September 30, 2012, the Company entered into a settlement agreement with the former equity holders of Prospectiv which resulted in a $0.7 million reduction of the initial purchase price and released the Company from any future claims for additional consideration and for future compensation based on achievement of the performance targets.
The Company concluded that the revisions made to the Prospectiv forecast, as well as other marketplace events, represented an indication of potential impairment of Prospectiv’s goodwill and intangible assets. As a result, during the three months ended June 30, 2012, the Company performed an interim impairment test of the goodwill for Prospectiv which is a separate reporting unit within the Membership Products reporting segment, as of April 1, 2012. Based on the impairment test, which used projected discounted cash flows to determine the fair value of Prospectiv and the implied fair value of the goodwill ascribed to Prospectiv, the Company recorded an impairment loss during the three months ended June 30, 2012 of $39.7 million, representing all of the goodwill ascribed to Prospectiv at the date of acquisition ($31.5 million) and a portion of the intangible assets of Prospectiv ($8.2 million).
3. | INTANGIBLE ASSETS |
Intangible assets consisted of:
March 31, 2013 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
(in millions) | ||||||||||||
Amortizable intangible assets: | ||||||||||||
Member relationships | $ | 940.5 | $ | (903.6 | ) | $ | 36.9 | |||||
Affinity relationships | 643.2 | (510.3 | ) | 132.9 | ||||||||
Proprietary databases and systems | 61.8 | (57.3 | ) | 4.5 | ||||||||
Trademarks and tradenames | 35.6 | (14.8 | ) | 20.8 | ||||||||
Patents and technology | 48.7 | (38.7 | ) | 10.0 | ||||||||
Covenants not to compete | 2.8 | (1.7 | ) | 1.1 | ||||||||
|
|
|
|
|
| |||||||
$ | 1,732.6 | $ | (1,526.4 | ) | $ | 206.2 | ||||||
|
|
|
|
|
| |||||||
December 31, 2012 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | ||||||||||
(in millions) | ||||||||||||
Amortizable intangible assets: | ||||||||||||
Member relationships | $ | 940.6 | $ | (899.0 | ) | $ | 41.6 | |||||
Affinity relationships | 648.2 | (503.6 | ) | 144.6 | ||||||||
Proprietary databases and systems | 61.9 | (57.1 | ) | 4.8 | ||||||||
Trademarks and tradenames | 35.9 | (14.3 | ) | 21.6 | ||||||||
Patents and technology | 48.3 | (36.9 | ) | 11.4 | ||||||||
Covenants not to compete | 2.8 | (1.6 | ) | 1.2 | ||||||||
|
|
|
|
|
| |||||||
$ | 1,737.7 | $ | (1,512.5 | ) | $ | 225.2 | ||||||
|
|
|
|
|
|
Foreign currency translation resulted in a decrease in intangible assets and accumulated amortization of $7.0 million and $5.3 million, respectively, from December 31, 2012 to March 31, 2013.
9
Table of Contents
Amortization expense relating to intangible assets was as follows:
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
(in millions) | ||||||||
Member relationships | $ | 6.0 | $ | 23.6 | ||||
Affinity relationships | 10.4 | 11.2 | ||||||
Proprietary databases and systems | 0.3 | 0.3 | ||||||
Trademarks and tradenames | 0.7 | 0.7 | ||||||
Patents and technology | 1.7 | 2.3 | ||||||
Covenants not to compete | 0.1 | 0.1 | ||||||
|
|
|
| |||||
$ | 19.2 | $ | 38.2 | |||||
|
|
|
|
Based on the Company’s amortizable intangible assets as of March 31, 2013, the Company expects the related amortization expense for fiscal year 2013 and the four succeeding fiscal years to be approximately $71.6 million in 2013, $59.6 million in 2014, $41.1 million in 2015, $12.2 million in 2016 and $8.2 million in 2017.
At January 1, 2013 and March 31, 2013, the Company had gross goodwill of $654.3 million and $648.9 million, respectively, and accumulated impairment losses of $47.0 million at both dates. The accumulated impairment losses represent the $15.5 million impairment loss recognized in 2006 impairing all of the goodwill assigned to the Loyalty Products segment related to the Apollo Transactions and the $31.5 million impairment loss recognized in 2012 impairing all of the goodwill assigned to the Membership Products segment related to the Prospectiv acquisition. The changes in the Company’s carrying amount of goodwill for the year ended December 31, 2012 and the three months ended March 31, 2013 are as follows:
Balance at January 1, 2012 | Acquisition | Impairment | Currency Translation | Balance at December 31, 2012 | Acquisitions | Currency Translation | Balance at March 31, 2013 | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
Membership products | $ | 413.5 | $ | — | $ | (31.5 | ) | $ | — | $ | 382.0 | $ | — | $ | — | $ | 382.0 | |||||||||||||||
Insurance and package products | 58.3 | — | — | — | 58.3 | — | — | 58.3 | ||||||||||||||||||||||||
Loyalty products | 81.7 | — | — | — | 81.7 | — | — | 81.7 | ||||||||||||||||||||||||
International products | 74.0 | 8.5 | — | 2.8 | 85.3 | (1.7 | ) | (3.7 | ) | 79.9 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||
Total | $ | 627.5 | $ | 8.5 | $ | (31.5 | ) | $ | 2.8 | $ | 607.3 | $ | (1.7 | ) | $ | (3.7 | ) | $ | 601.9 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In late March of 2012, Prospectiv implemented a reduction in force and revised its growth plans for 2012 and 2013. The Company concluded that the revisions made to the Prospectiv forecast, as well as other marketplace events, represented an indication of potential impairment of Prospectiv’s goodwill and intangible assets. As a result, during the three months ended June 30, 2012, the Company performed an interim impairment test of the goodwill for Prospectiv, which is a separate reporting unit within the Membership Products reporting segment. Based on the interim impairment test, which used discounted cash flows to determine the fair value of Prospectiv and the implied fair value of the goodwill ascribed to Prospectiv, the Company recorded an impairment loss during the three months ended June 30, 2012 of $31.5 million, representing all of the goodwill ascribed to Prospectiv at the date of acquisition. During the three months ended June 30, 2012, the Company also performed an impairment test related to the intangible assets of Prospectiv and, based on the impairment test, recorded an impairment loss related to the Prospectiv intangible assets of $8.2 million, related to proprietary databases and systems ($1.0 million), trademarks and tradenames ($5.4 million) and patents and technology ($1.8 million).
The change in goodwill of International products in 2013 is attributable to a purchase price adjustment in connection with the November 14, 2012 acquisition of Back-Up and Travel (see Note 2 – Acquisitions).
10
Table of Contents
4. | CONTRACT RIGHTS AND LIST FEES, NET |
Contract rights and list fees consisted of:
March 31, 2013 | December 31, 2012 | |||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Contract rights | $ | 57.7 | $ | (56.8 | ) | $ | 0.9 | $ | 61.2 | $ | (60.2 | ) | $ | 1.0 | ||||||||||
List fees | 46.1 | (25.5 | ) | 20.6 | 45.1 | (24.1 | ) | 21.0 | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
$ | 103.8 | $ | (82.3 | ) | $ | 21.5 | $ | 106.3 | $ | (84.3 | ) | $ | 22.0 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense for the three months ended March 31, 2013 was $1.5 million, of which $1.4 million is included in marketing expense and $0.1 million is included in depreciation and amortization expense in the unaudited condensed consolidated statements of comprehensive income. Amortization expense for the three months ended March 31, 2012 was $1.4 million, of which $1.3 million is included in marketing expense and $0.1 million is included in depreciation and amortization expense in the unaudited condensed consolidated statements of comprehensive income. Based on the Company’s contract rights and list fees as of March 31, 2013, the Company expects the related amortization expense for fiscal year 2013 and the four succeeding fiscal years to be approximately $6.0 million in 2013, $4.9 million in 2014, $4.0 million in 2015, $2.8 million in 2016 and $1.7 million in 2017.
5. | LONG-TERM DEBT |
Long-term debt consisted of:
March 31, 2013 | December 31, 2012 | |||||||
(in millions) | ||||||||
Term loan due 2016 | $ | 1,093.1 | $ | 1,095.9 | ||||
7.875% senior notes due 2018, net of unamortized discount of $2.5 and $2.6, respectively, with an effective interest rate of 8.00% | 472.5 | 472.4 | ||||||
11 1/2% senior subordinated notes due 2015, net of unamortized discount of $1.3 and $1.5, respectively, with an effective interest rate of 11.75% | 354.2 | 354.0 | ||||||
11.625% senior notes due 2015, net of unamortized discount of $2.4 and $2.6, respectively, with an effective interest rate of 12.00% | 322.6 | 322.4 | ||||||
Capital lease obligations | 1.1 | 1.3 | ||||||
|
|
|
| |||||
Total debt | 2,243.5 | 2,246.0 | ||||||
Less: current portion of long-term debt | (11.7 | ) | (11.8 | ) | ||||
|
|
|
| |||||
Long-term debt | $ | 2,231.8 | $ | 2,234.2 | ||||
|
|
|
|
On April 9, 2010, Affinion, as Borrower, and Affinion Holdings entered into a $1.0 billion amended and restated senior secured credit facility with Affinion’s lenders (“Affinion Credit Facility”). On November 20, 2012, Affinion, as Borrower, and Affinion Holdings entered into an amendment to the Affinion Credit Facility, which (i) increased the margins on LIBOR loans from 3.50% to 5.00% and on base rate loans from 2.50% to 4.00%, (ii) replaced the financial covenant requiring Affinion to maintain a maximum consolidated leverage ratio with a financial covenant requiring Affinion to maintain a maximum senior secured leverage ratio, and (iii) adjusted the ratios under the financial covenant requiring Affinion to maintain a minimum interest coverage ratio. The amended Affinion Credit Facility consists of a five-year $165.0 million revolving credit facility (pursuant to an agreement with two of Affinion’s lenders on December 13, 2010 to increase the revolving credit facility ) and an $875.0 million term loan facility. On February 11, 2011, Affinion obtained incremental term loans in an aggregate principal amount of $250.0 million under its amended and restated senior secured credit facility. The revolving credit facility includes a letter of credit subfacility and a swingline loan subfacility. The term loan facility matures in October 2016. However the term loan facility will mature on the date that is 91 days prior to the maturity of the Senior Subordinated Notes unless, prior to that date, (a) the maturity for the Senior Subordinated Notes is extended to a date that is at least 91 days after the maturity of the term loan facility or (b) the obligations under the Senior Subordinated Notes are (i) repaid in full or (ii) refinanced, replaced or defeased in full with new loans and/or debt securities with maturity dates occurring after the maturity date of the term loan facility. The term loan facility provides for quarterly amortization payments totaling 1% per annum, with the balance payable upon the final maturity date. The term loan facility also requires mandatory prepayments of the outstanding term loans based on excess cash flow (as defined), if any, and the proceeds from certain specified transactions. The interest rates with respect to term loans and revolving loans under the Affinion Credit Facility are based on, at Affinion’s option, (a) the higher of (i) adjusted LIBOR and (ii) 1.50%, in each case plus 5.00%, or (b) the highest of (i) Deutsche Bank Trust Company Americas’ prime rate, (ii) the Federal Funds Effective Rate plus 0.5% and (iii) 2.50% (“ABR”), in each case plus 4.00%. The effective interest rate on the term loan for the three months ended March 31, 2013 and 2012 was 6.5% and 5.0% per annum, respectively. Affinion’s
11
Table of Contents
obligations under the credit facility are, and Affinion’s obligations under any interest rate protection or other hedging arrangements entered into with a lender or any of its affiliates will be, guaranteed by Affinion Holdings and by each of Affinion’s existing and subsequently acquired or organized domestic subsidiaries, subject to certain exceptions . The credit facility is secured to the extent legally permissible by substantially all of the assets of (i) Affinion Holdings, which consists of a pledge of all of Affinion’s capital stock and (ii) Affinion and the subsidiary guarantors, including but not limited to: (a) a pledge of substantially all capital stock held by Affinion or any subsidiary guarantor and (b) security interests in substantially all tangible and intangible assets of Affinion and each subsidiary guarantor, subject to certain exceptions. The credit facility also contains financial, affirmative and negative covenants. The negative covenants in Affinion’s credit facility include, among other things, limitations (all of which are subject to certain exceptions) on Affinion’s (and in certain cases, Affinion Holdings’) ability to: declare dividends and make other distributions, redeem or repurchase Affinion’s capital stock; prepay, redeem or repurchase certain of Affinion’s subordinated indebtedness; make loans or investments (including acquisitions); incur additional indebtedness (subject to certain exceptions); enter into agreements that would restrict the ability of Affinion’s subsidiaries to pay dividends; merge or enter into acquisitions; sell assets; and enter into transactions with affiliates. The credit facility also requires Affinion to comply with financial maintenance covenants with a maximum ratio of senior secured debt, as defined, to EBITDA (as defined) and a minimum ratio of EBITDA to cash interest expense. The proceeds of the term loan under the Affinion Credit Facility were utilized to repay the outstanding balance of Affinion’s previously existing senior secured term loan, including accrued interest, of $629.7 million and pay fees and expenses of approximately $27.0 million. The remaining proceeds are available for working capital and other general corporate purposes, including permitted acquisitions and investments. In connection with the refinancing, the Company recorded a loss on extinguishment of debt of approximately $7.4 million during the year ended December 31, 2010 representing the write-off of the unamortized balance of the deferred financing costs associated with Affinion’s prior credit facility.
As of March 31, 2013 and December 31, 2012, there were no outstanding borrowings under the revolving credit facility. Borrowings and repayments under the revolving credit facility were $30.0 million and $30.0 million, respectively, during the three months ended March 31, 2013. There were no borrowings or repayments under the revolving credit facility during the three months ended March 31, 2012. As of March 31, 2013, Affinion had $151.8 million available for borrowing under the Affinion Credit Facility after giving effect to the issuance of $13.2 million of letters of credit issued under the Affinion Credit Facility.
On October 5, 2010, the Company issued $325.0 million aggregate principal amount of 11.625% senior notes due November 2015 (the “11.625% senior notes”). The Company used a portion of the proceeds of $320.3 million (net of discount), along with proceeds from a cash dividend from Affinion in the amount of $115.3 million, to repay in full the Company’s then-outstanding senior unsecured term loan. A portion of the remaining proceeds from the offering of the 11.625% senior notes were utilized to pay related fees and expenses of approximately $6.7 million, with the balance retained for general corporate purposes. The fees and expenses were capitalized and are being amortized over the term of the 11.625% senior notes. On August 24, 2011, pursuant to the registration rights agreement entered into in connection with the issuance of the 11.625% senior notes, the Company completed a registered exchange offer and exchanged all of the then-outstanding 11.625% senior notes for a like principal amount of 11.625% senior notes that have been registered under the Securities Act of 1933, as amended (the “Securities Act”).
On November 19, 2010, Affinion completed a private offering of $475.0 million aggregate principal amount of 7.875% Senior Notes due 2018 (“2010 Senior Notes”). The 2010 Senior Notes bear interest at 7.875% per annum payable semi-annually on June 15 and December 15 of each year, commencing on June 15, 2011. The 2010 Senior Notes will mature on December 15, 2018. The 2010 Senior Notes are redeemable at Affinion’s option prior to maturity. The indenture governing the 2010 Senior Notes contains negative covenants which restrict the ability of Affinion and its restricted subsidiaries to engage in certain transactions and also contains customary events of default. Affinion’s obligations under the 2010 Senior Notes are jointly and severally and fully and unconditionally guaranteed on a senior secured basis by each of Affinion’s existing and future domestic subsidiaries that guarantee Affinion’s indebtedness under the Affinion Credit Facility. The 2010 Senior Notes and guarantees thereof are senior unsecured obligations of Affinion and rank equally with all of Affinion’s and the guarantors’ existing and future senior indebtedness and senior to Affinion’s and the guarantors’ existing and future subordinated indebtedness. The 2010 Senior Notes are therefore effectively subordinated to Affinion’s and the guarantors’ existing and future secured indebtedness, including Affinion’s obligations under the Affinion Credit Facility, to the extent of the value of the collateral securing such indebtedness. The 2010 Senior Notes are structurally subordinated to all indebtedness and other obligations of each of Affinion’s existing and future subsidiaries that are not guarantors. On August 24, 2011, pursuant to the registration rights agreement entered into in connection with the issuance of the 2010 Senior Notes, Affinion completed a registered exchange offer and exchanged all of the then-outstanding 2010 Senior Notes for a like principal amount of 2010 Senior Notes that have been registered under the Securities Act. Affinion used substantially all of the net proceeds of the offering of the 2010 Senior Notes to finance the purchase of the previously outstanding senior notes issued in 2005, 2006 and 2009.
On April 26, 2006, Affinion issued $355.5 million aggregate principal amount of 11 1/2% senior subordinated notes due October 15, 2015 (the “Senior Subordinated Notes”). The Senior Subordinated Notes bear interest at 11 1/2% per annum, payable semi-annually, on April 15 and October 15 of each year. The Senior Subordinated Notes mature on October 15, 2015. Since October 15, 2010, Affinion has had the right to redeem some or all of the Senior Subordinated Notes at any time at redemption prices (generally at a premium) set forth in the indenture governing the Senior Subordinated Notes. The Senior Subordinated Notes are unsecured obligations of Affinion and rank junior in right of payment with Affinion’s existing and future senior obligations and senior to
12
Table of Contents
Affinion’s future subordinated indebtedness. The Senior Subordinated Notes are guaranteed by the same subsidiaries of Affinion that guarantee the Affinion Credit Facility and the 2010 Senior Notes. On September 13, 2006, Affinion completed a registered exchange offer and exchanged all of the then-outstanding 11 1/2% Senior Subordinated Notes due 2015 for a like principal amount of 11 1/2% Senior Subordinated Notes due 2015 that have been registered under the Securities Act.
The Affinion Credit Facility and the indentures governing the 2010 Senior Notes and the Senior Subordinated Notes each contain restrictive covenants related primarily to Affinion’s ability to distribute dividends to the Company, redeem or repurchase capital stock, sell assets, issue additional debt or merge with or acquire other companies. Affinion and its subsidiaries may pay dividends of up to $40.0 million in the aggregate provided that no default or event of default has occurred or is continuing, or would result from the dividend. Payment of additional dividends requires the satisfaction of various conditions, including meeting defined leverage ratios and defined fixed charge and interest coverage ratios, and the total dividend paid cannot exceed a calculated amount of defined available free cash flow or consolidated net income. The covenants in the Affinion Credit Facility also require compliance with a senior secured leverage ratio and an interest coverage ratio. During the three months ended March 31, 2013 and 2012, Affinion did not pay any cash dividends to Affinion Holdings. Affinion was in compliance with the covenants referred to above as of March 31, 2013. Payment under each of the debt agreements may be accelerated in the event of a default. Events of default include the failure to pay principal and interest when due, covenant defaults (unless cured within applicable grace periods, if any), events of bankruptcy and, for the amended Affinion Credit Facility, a material breach of representation or warranty and a change of control.
As of March 31, 2013, Affinion was in compliance with all financial covenants contained in the Affinion Credit Facility and the indentures governing the 2010 Senior Notes and the Senior Subordinated Notes and the Company was in compliance with all financial covenants contained in the indenture governing the 11.625% senior notes.
6. | INCOME TAXES |
The income tax provision is determined using the asset and liability method, under which deferred tax assets and liabilities are calculated based upon the temporary differences between the financial statements and income tax bases of assets and liabilities using currently enacted tax rates. Deferred tax assets are recorded net of a valuation allowance when, based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. Decreases to the valuation allowance are recorded as reductions to the income tax provision, while increases to the valuation allowance result in additional income tax provision. The realization of deferred tax assets is primarily dependent on estimated future taxable income. As of March 31, 2013 and 2012, the Company has recorded a full valuation allowance for its U.S. federal net deferred tax assets. As of March 31, 2013 and 2012, the Company has also recorded valuation allowances against the deferred tax assets related to certain state and foreign tax jurisdictions.
The Company’s effective income tax rates for the three months ended March 31, 2013 and 2012 were (54.1)% and (25.9)% respectively. The difference in the effective tax rates for the three months ended March 31, 2013 and 2012 is primarily a result of the decrease in loss before income taxes and non-controlling interest from $10.5 million for the three months ended March 31, 2012 to $9.5 million for the three months ended March 31, 2013 and an increase in the income tax provision from $2.7 million for the three months ended March 31, 2012 to $5.1 million for the three months ended March 31, 2013. The Company’s tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income it earns in those jurisdictions. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. In addition to state and foreign income taxes and related foreign tax credits, the requirement to maintain valuation allowances had the most significant impact on the difference between the Company’s effective tax rate and the statutory U.S. federal income tax rate of 35%.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. The Company recognized less than $0.1 million of interest related to uncertain tax positions arising in the three months ended March 31, 2013. The interest has been included in income tax expense for the current period. The Company’s gross unrecognized tax benefits for the three months ended March 31, 2013 increased by $5.7 million as a result of tax positions taken during the current period, which was offset by a valuation allowance.
The Company’s income tax returns are periodically examined by various tax authorities. In connection with these and future examinations, certain tax authorities, including the Internal Revenue Service, may raise issues and impose additional assessments. The Company regularly evaluates the likelihood of additional assessments resulting from these examinations and establishes liabilities, through the provision for income taxes, for potential amounts that may result therefrom. The recognition of uncertain tax benefits are not expected to have a material impact on the Company’s effective tax rate or results of operations. Federal, state and local jurisdictions are subject to examination by the taxing authorities for all open years as prescribed by applicable statute. For significant foreign jurisdictions, tax years in Germany and the United Kingdom remain open. No income tax waivers have been executed that would extend the period subject to examination beyond the period prescribed by statute. The Company does not believe that it is reasonably possible that the total amount of unrecognized tax benefits will change significantly within the next 12 months. Any income tax liabilities or refunds relating to periods prior to October 17, 2005 are the responsibility of Cendant as discussed in Note 9 – Related Party Transactions.
13
Table of Contents
7. | COMMITMENTS AND CONTINGENCIES |
Litigation
In the ordinary course of business, the Company is involved in claims, governmental inquiries and legal proceedings related to employment matters, contract disputes, business practices, trademark and copyright infringement claims and other commercial matters. The Company is also a party to lawsuits which were brought against it and its affiliates and which purport to be a class action in nature and allege that the Company violated certain federal or state consumer protection statutes (as described below). The Company intends to vigorously defend itself against such lawsuits.
On June 17, 2010, a class action complaint was filed against the Company and Trilegiant Corporation (“Trilegiant”) in the United States District Court for the District of Connecticut. The complaint asserts various causes of action on behalf of a putative nationwide class and a California-only subclass in connection with the sale by Trilegiant of its membership programs, including claims under the Electronic Communications Privacy Act, the Connecticut Unfair Trade Practices Act, the Racketeer Influenced Corrupt Organizations Act, the California Consumers Legal Remedies Act, the California Unfair Competition Law, the California False Advertising Law, and for unjust enrichment. On September 29, 2010, the Company filed a motion to compel arbitration of all of the claims asserted in this lawsuit. On February 24, 2011, the court denied the Company’s motion. On March 28, 2011, the Company and Trilegiant filed a notice of appeal in the United States Court of Appeals for the Second Circuit, appealing the district court’s denial of their motion to compel arbitration. On September 7, 2012, the Second Circuit affirmed the decision of the District Court denying arbitration. While that issue was on appeal, the matter proceeded in the district court. There was written discovery and depositions. Previously, the court had set a briefing schedule on class certification that called for the completion of class certification briefing on May 18, 2012. However, on March 28, 2012, the court suspended the briefing schedule on the motion due to the filing of two other overlapping class actions in the United States District Court for the District of Connecticut. The first of those cases was filed on March 6, 2012, against the Company, Trilegiant, Chase Bank USA, N.A., Bank of America, N.A., Capital One Financial Corp., Citigroup, Inc., Citibank, N.A., Apollo Global Management, LLC, 1-800-Flowers.Com, Inc., United Online, Inc., Memory Lane, Inc., Classmates Int’l, Inc., FTD Group, Inc., Days Inn Worldwide, Inc., Wyndham Worldwide Corp., People Finderspro, Inc., Beckett Media LLC, Buy.com, Inc., Rakuten USA, Inc., IAC/InteractiveCorp., and Shoebuy.com, Inc. The second of those cases was filed on March 25, 2012, against the same defendants as well as Adaptive Marketing, LLC, Vertrue, Inc., Webloyalty.com, Inc., and Wells Fargo & Co. These two cases assert similar claims as the claims asserted in the earlier-filed lawsuit in connection with the sale by Trilegiant of its membership programs. On April 26, 2012, the court consolidated these three cases. The court also set an initial status conference for May 17, 2012. At that status conference, the court ordered that Plaintiffs file a consolidated amended complaint to combine the claims in the three previously separate lawsuits. The court also struck the class certification briefing schedule that had been set previously. On September 7, 2012, the Plaintiffs filed a consolidated amended complaint asserting substantially the same legal claims. The consolidated amended complaint added Priceline, Orbitz, Chase Paymentech, Hotwire, and TigerDirect as Defendants and added three new Plaintiffs; it also dropped Webloyalty and Rakuten as Defendants. On December 7, 2012, all Defendants filed motions seeking to dismiss the consolidated amended complaint and to strike certain portions of the complaint. Plaintiff’s response brief was filed on February 7, 2013, and Defendants’ reply briefs were filed on April 5, 2013. The Company does not know when the court will rule on that motion. Also, on December 5, 2012, the Plaintiffs’ law firms in these consolidated cases filed an additional action in the United States District Court for the District of Connecticut. That case is identical in all respects to this case except that it was filed by a new Plaintiff (the named Plaintiff from the class action complaint previously filed against the Company, Trilegiant, 1-800-Flowers.com, and Chase Bank USA, N.A., in the United States District Court for the Eastern District of New York on November 10, 2010). On January 23, 2013, Plaintiff filed a motion to consolidate that case into the existing set of consolidated cases. The Company does not know when the court will rule on that motion. On February 15, 2013, the Court entered an order staying the date for all Defendants to respond to the Complaint until (1) the resolution of the motion to consolidate the case into the existing consolidated cases, or (2) April 1, 2013. Because the motion to consolidate has not been resolved, the stay remains in effect, and Defendants have informed the court of that fact and asked that the stay continue to remain in effect pending resolution of that motion.
On June 25, 2010, a class action lawsuit was filed against Webloyalty and one of its clients in the United States District Court for the Southern District of California alleging, among other things, violations of the Electronic Fund Transfer Act and Electronic Communications Privacy Act, unjust enrichment, fraud, civil theft, negligent misrepresentation, fraud, California Consumers Legal Remedies Act violations, false advertising and California Consumer Business Practice violations. This lawsuit relates to Webloyalty’s alleged conduct occurring on and after October 1, 2008. On February 17, 2011, Webloyalty filed a motion to dismiss the amended complaint in this lawsuit. On April 12, 2011, the Court granted Webloyalty’s motion and dismissed all claims against the defendants. On May 10, 2011, plaintiff filed a notice appealing the dismissal to the United States Court of Appeals for the Ninth Circuit. Plaintiff filed its opening appeals brief with the Ninth Circuit on October 17, 2011, and defendants filed their respective answering briefs on December 23, 2011. Plaintiff filed its reply brief on January 23, 2012. On January 11, 2013, the Ninth Circuit heard oral argument on the plaintiff’s appeal and, thereafter, took the matter under advisement.
On August 27, 2010, another substantially similar class action lawsuit was filed against Webloyalty, one of its former clients and one of the credit card associations in the United States District Court for the District of Connecticut alleging, among other things, violations of the Electronic Fund Transfer Act, Electronic Communications Privacy Act, unjust enrichment, civil theft, negligent
14
Table of Contents
misrepresentation, fraud and Connecticut Unfair Trade Practices Act violations. This lawsuit relates to Webloyalty’s alleged conduct occurring on and after October 1, 2008. On December 23, 2010, Webloyalty filed a motion to dismiss this lawsuit, which had since been amended in its entirety. The court has not yet scheduled a hearing or ruled on Webloyalty’s motion.
On June 7, 2012, another class action lawsuit was filed in the U.S. District Court for the Southern District of California against Webloyalty that was factually similar to the foregoing California and Connecticut actions. The action claims that Webloyalty engaged in unlawful business practices in violation of California Business and Professional Code § 17200, et seq. and in violation of the Connecticut Unfair Trade Practices Act. Both claims are based on allegations that in connection with enrollment and billing of the plaintiff, Webloyalty charged plaintiff’s credit or debit card using information obtained through a data pass process and without obtaining directly from plaintiff his full account number, name, address, and contact information, as purportedly required under Restore Online Shoppers’ Confidence Act. On September 25, 2012, Webloyalty filed a motion to dismiss the complaint in its entirety, scheduling a hearing on the motion for January 14, 2013. Webloyalty also sought judicial notice of the enrollment page and related enrollment and account documents. Plaintiff filed his opposition on December 12, 2012, and Webloyalty filed its reply submission on January 7, 2013. Thereafter, on January 10, 2013, the Court cancelled the previously scheduled January 14, 2013 hearing and indicated that it would rule based on the parties’ written submissions without the need for a hearing, although it has not yet done so.
The Company and Trilegiant are also a party to lawsuits arising out of the inquiries made by the state attorneys general.
On October 14, 2010, the Company and Trilegiant filed a declaratory relief action against the State of South Carolina, in the Court of Common Pleas of South Carolina for the County of Richland, Fifth Judicial Circuit, seeking a declaratory judgment that their marketing practices comply with South Carolina law. The Company and Trilegiant also seek a declaratory judgment that the State may not appoint private counsel to bring an action against the Company and Trilegiant on the State’s behalf. The State has filed a motion to dismiss both requests for declaratory judgment. On December 17, 2010, the State of South Carolina appointed private counsel and filed a civil action against the Company and Trilegiant, in the Court of Common Pleas of South Carolina for the County of Spartanburg, Seventh Judicial Circuit, under the South Carolina Unfair Trade Practices Act, seeking civil penalties, restitution and an injunction. On December 31, 2010, the State filed its First Amended Complaint naming the Company, Trilegiant, and certain current and former officers as defendants. Also on December 31, 2010, the State filed its Notice of Motion and Motion for a Temporary Injunction. The case has been dismissed and the Company and Trilegiant resolved this matter through settlement. In this regard, the Company finalized, in December 2012, Assurances of Discontinuance and Voluntary Compliance with the South Carolina Attorney General’s Office regarding online marketing practices, pursuant to which the Company has paid $3.9 million in consumer education, costs and fees, including special counsel fees for the state’s outside counsel, and has agreed to make restitution payments to eligible South Carolina consumers who submit a valid claim form. The Company believes that the amount it has accrued for such restitution payments is adequate and that the amounts actually paid will not be material.
On November 24, 2010, the State of Iowa filed an action against the Company, Trilegiant, and the Company’s Chief Executive Officer, in the Iowa District Court for Polk County. This action was superseded by an action filed on March 11, 2011. The superseding action does not name the Company’s Chief Executive Officer and alleges violations of Iowa’s Buying Club Law, and seeks injunctive relief as well as monetary relief. Subsequently the case has been dismissed without prejudice on the state’s own motion. The Company is attempting to resolve the matter through settlement but no assurance is made that a settlement will be reached.
Other Contingencies
From time to time, the Company receives inquiries from federal and state agencies which may include the Federal Trade Commission, the Federal Communications Commission, the Consumer Financial Protection Bureau, state attorneys general and other state regulatory agencies, including state insurance regulators. The Company responds to these matters and requests for documents, some of which may lead to further investigations and proceedings.
Between December 2008 and February 2011, the Company and Webloyalty received inquiries from numerous state attorneys general relating to the marketing of their membership programs and their compliance with consumer protection statutes. The Company and Webloyalty have responded to the states’ request for documents and information and are in active discussions with such states regarding their investigations and the resolution of these matters. Settlement of such matters may include payment by the Company and Webloyalty to the states, restitution to consumers and injunctive relief.
In that regard, in August 2010, the Company entered into a voluntary Assurance of Discontinuance with the New York Attorney General’s Office. Pursuant to that settlement, the Company agreed to cease in New York its online marketing practices relating to the acquisition of consumers’ credit or debit card account numbers automatically from its retailer or merchant marketing partners when a consumer enrolls in one of the Company’s programs after making a purchase through one of such partners’ web sites as previously agreed to with the U.S. Senate Committee on Commerce, Science and Transportation on January 6, 2010. Additionally, the Company agreed, among other things, with the New York Attorney General’s Office to cease in New York “live check” marketing whereby a consumer enrolls in a program or service by endorsing and cashing a check. As part of such settlement, the Company paid $3.0 million in fees, costs, and penalties and approximately $1.8 million as restitution to New York consumers in addition to refund claims.
15
Table of Contents
As of September 13, 2010, Webloyalty also entered into a similar settlement agreement with the New York Attorney General’s Office. Pursuant to that settlement, Webloyalty agreed to pay $5.2 million in costs, fines and penalties, establish a restitution program for certain New York residents that joined a Webloyalty membership program between October 1, 2008 and January 13, 2010 and submitted a valid claim form, and implement changes to Webloyalty’s marketing of its membership programs. All costs, fines and penalties relating to the settlement were paid by Webloyalty in October 2010. Restitution to New York consumers in the amount of $2.6 million was fully paid in the second quarter of 2011.
From time to time Affinion International receives inquiries from the Financial Services Authority in the United Kingdom (the “FSA”) regarding its products. The Company is in active discussions with the FSA to resolve a matter related to its historic sales practices pertaining to a benefit in one of its products. Resolution of this inquiry may include changes to its business practices in a limited business line, monetary fines and/or restitution to consumers.
The Company believes that the amount accrued for the above litigation and contingencies matters is adequate, and the reasonably possible loss beyond the amounts accrued will not have a material effect on its consolidated financial statements, taken as a whole, based on information currently available. However, litigation is inherently unpredictable and, although the Company believes that accruals are adequate and it intends to vigorously defend itself against such matters, unfavorable resolution could occur, which could have a material effect on the Company’s consolidated financial statements, taken as a whole.
Surety Bonds and Letters of Credit
In the ordinary course of business, the Company is required to provide surety bonds to various state authorities in order to operate its membership, insurance and travel agency programs. As of March 31, 2013, the Company provided guarantees for surety bonds totaling approximately $11.9 million and issued letters of credit totaling $14.2 million.
8. | STOCK-BASED COMPENSATION |
In connection with the closing of the Apollo Transactions on October 17, 2005, Affinion Holdings adopted the 2005 Stock Incentive Plan (the “2005 Plan”). The 2005 Plan authorizes the Board of Directors (the “Board”) of Affinion Holdings to grant non-qualified, non-assignable stock options and rights to purchase shares of Affinion Holdings’ common stock to directors and employees of, and consultants to, Affinion Holdings and its subsidiaries. Options granted under the 2005 Plan have an exercise price no less than the fair market value of a share of the underlying common stock on the date of grant. Stock awards have a purchase price determined by the Board. The Board was authorized to grant up to 4.9 million shares of Affinion Holdings’ common stock under the 2005 Plan over a ten year period. As discussed below, no additional grants may be made under Affinion Holdings’ 2005 Plan on or after November 7, 2007, the effective date of the 2007 Plan, as defined below.
In November 2007, Affinion Holdings adopted the 2007 Stock Award Plan (the “2007 Plan”). The 2007 Plan authorizes the Board to grant awards of non-qualified stock options, incentive stock options, stock appreciation rights, restricted stock awards, restricted stock units, stock bonus awards, performance compensation awards (including cash bonus awards) or any combination of these awards to directors and employees of, and consultants to, Affinion Holdings and its subsidiaries. Unless otherwise determined by the Board of Directors, options granted under the 2007 Plan will have an exercise price no less than the fair market value of a share of the underlying common stock on the date of grant. Stock awards have a purchase price determined by the Board. The Board was authorized to grant up to 10.0 million shares of Affinion Holdings’ common stock under the 2007 Plan over a ten year period. As of March 31, 2013, there were 5.6 million shares available under the 2007 Plan for future grants.
In connection with the acquisition of Webloyalty in January 2011, the Company assumed the webloyalty.com, inc. Incentive Stock Option Plan (the “webloyalty.com ISO Plan”), the webloyalty.com, inc. Non-Qualified Stock Option Plan (the “webloyalty.com NQ Plan”) and the Webloyalty Holdings, Inc. 2005 Equity Award Plan (the “Webloyalty 2005 Plan”). The webloyalty.com ISO Plan, adopted by Webloyalty’s board of directors in February 1999, authorized Webloyalty’s board of directors to grant awards of incentive stock options to directors and employees of, and consultants to, Webloyalty over a ten year period. During the three months ended March 31, 2013, there were no outstanding options under the webloyalty.com ISO Plan. No additional grants may be made under the webloyalty.com ISO Plan.
The webloyalty.com NQ Plan, adopted by Webloyalty’s board of directors in February 1999, as amended and restated in February 2004, authorized Webloyalty’s board of directors to grant awards of stock options to directors and employees of, and consultants to, Webloyalty. The Webloyalty board of directors was authorized to grant shares of Webloyalty’s common stock under the webloyalty.com NQ Plan over a ten year period. During the three months ended March 31, 2013, there were no outstanding options under the webloyalty.com NQ Plan. No additional grants may be made under the webloyalty.com NQ Plan.
The Webloyalty 2005 Plan, adopted by Webloyalty’s board of directors in May 2005, authorized Webloyalty’s board of directors to grant awards of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, stock bonuses and performance compensation awards or any combination of these awards to directors and employees of, and consultants to, Webloyalty. Unless otherwise determined by Webloyalty’s board of directors, incentive stock options granted
16
Table of Contents
under the Webloyalty 2005 Plan were to have an exercise price no less than the fair market value of a share of the underlying common stock on the date of grant and nonqualified stock options granted under the Webloyalty 2005 Plan were to have an exercise price no less than the par value of a share of Webloyalty’s common stock on the date of grant. The Webloyalty board of directors was authorized to grant shares of Webloyalty’s common stock under the Webloyalty 2005 Plan over a ten year period. As of March 31, 2013, after conversion of the outstanding options under the Webloyalty 2005 Plan into options to acquire shares of Affinion Holdings’ common stock, there were options to acquire 0.6 million shares of Affinion Holdings’ common stock at exercise prices ranging from $3.33 to $12.95. All of the outstanding options were vested as of March 31, 2013 and expire between May 2015 and September 2018.
For employee stock awards, the Company recognizes compensation expense, net of estimated forfeitures, over the requisite service period, which is the period during which the employee is required to provide services in exchange for the award. The Company has elected to recognize compensation cost for awards with only a service condition and have a graded vesting schedule on a straight-line basis over the requisite service period for the entire award.
Stock Options
During the three months ended March 31, 2013 and 2012, there were no stock options granted to employees from the 2005 Plan. All options previously granted were granted with an exercise price equal to the estimated fair market value of a share of the underlying common stock on the date of grant. Stock options granted to employees from the 2005 Plan are comprised of three tranches with the following terms:
Tranche A | Tranche B | Tranche C | ||||
Vesting | Ratably over 5 years* | 100% after 8 years** | 100% after 8 years** | |||
Term of option | 10 years | 10 years | 10 years |
* | In the event of a sale of the Company, vesting for tranche A occurs 18 months after the date of sale. |
** | Tranche B and C vesting would be accelerated upon specified realized returns to Apollo. |
There were no stock options granted to employees from the 2007 Plan during the three months ended March 31, 2013 and 2012. All options previously granted were granted with an exercise price equal to the estimated fair market value of a share of the underlying common stock on the date of grant.
The stock options granted to employees from the 2007 Plan have the following terms:
Vesting period | Ratably over 4 years | |
Option term | 10 years |
During the three months ended March 31, 2013 and 2012, there were no stock options granted to members of the Board of Directors. Generally, options granted to members of the Board of Directors fully vest on the date of grant and have an option term of 10 years.
The fair value of each option award from the 2007 Plan was estimated on the date of grant using the Black-Scholes option-pricing model based on the assumptions noted in the following table. Expected volatilities are based on historical volatilities of comparable companies. The expected term of the options granted represents the period of time that options are expected to be outstanding, and is based on the average of the requisite service period and the contractual term of the option.
2012 Grants | ||
Expected volatility | 50% | |
Expected life (in years) | 5.89-6.25 | |
Risk-free interest rate | 1.15% | |
Expected dividends | — |
17
Table of Contents
A summary of option activity for the three months ended March 31, 2013 is presented below (number of options in thousands):
2005 Plan – Grants to Employees- Tranche A | 2005 Plan – Grants to Employees- Tranche B | 2005 Plan – Grants to Employees- Tranche C | Grants to Board of Directors | 2007 Plan – Grants to Employees | ||||||||||||||||
Outstanding options at January 1, 2013 | 1,390 | 681 | 681 | 423 | 3,562 | |||||||||||||||
Granted | — | — | — | — | — | |||||||||||||||
Exercised | — | — | — | — | — | |||||||||||||||
Forfeited or expired | (13 | ) | (3 | ) | (3 | ) | — | (72 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Outstanding options at March 31, 2013 | 1,377 | 678 | 678 | 423 | 3,490 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Vested or expected to vest at March 31, 2013 | 1,377 | 678 | 678 | 423 | 3,490 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Exercisable options at March 31, 2013 | 1,377 | — | — | 423 | 1,884 | |||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Weighted average remaining contractual term (in years) | 2.7 | 2.7 | 2.7 | 4.6 | 7.6 | |||||||||||||||
Weighted average grant date fair value per option granted in 2013 | $ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
Weighted average exercise price of exercisable options at March 31, 2013 | $ | 1.52 | $ | — | $ | — | $ | 4.95 | $ | 10.95 | ||||||||||
Weighted average exercise price of outstanding options at March 31, 2013 | $ | 1.52 | $ | 1.52 | $ | 1.52 | $ | 4.95 | $ | 10.04 |
Based on the estimated fair values of options granted, stock-based compensation expense for the three months ended March 31, 2013 and 2012 totaled $1.1 million and $1.2 million, respectively. As of March 31, 2013, there was $6.2 million of unrecognized compensation cost related to unvested stock options, which will be recognized over a weighted average period of approximately 1.0 years.
Restricted Stock Units
On January 13, 2010, the Board’s Compensation Committee approved the Amended and Restated 2010 Retention Award Program (the “2010 RAP”), which provided for awards of restricted stock units (“RSUs”) under the 2007 Stock Award Plan and granted approximately 942,000 RSUs to key employees. The RSUs initially awarded under the 2010 RAP had an aggregate cash election dollar value of approximately $9.9 million and were subject to time-based vesting conditions that ran through approximately the first quarter of 2012. Generally, the number of RSUs awarded to each participant was equal to the quotient of (i) the aggregate cash election dollar value of RSUs awarded to such participant (the “Dollar Award Value”) multiplied by 1.2, divided by (ii) $12.63 (i.e. the value per share of Affinion Holdings’ common stock as of December 31, 2009). Upon vesting of the RSUs, participants could settle the RSUs in shares of common stock or elect to receive cash in lieu of shares of common stock upon any of the four vesting dates for such RSUs in an amount equal to one-fourth of the Dollar Award Value. During 2010 and 2011, the Board issued additional grants totaling 159,000 RSUs to key employees under substantially the same terms. Due to the ability of the participants to settle their awards in cash, the Company accounted for these RSUs as a liability award.
On March 30, 2012, the Board’s Compensation Committee approved the 2012 Retention Award Program (the “2012 RAP”), which provides for awards of RSUs under the 2007 Stock Award Plan. During the year ended December 31, 2012, the Company granted approximately 1.4 million RSUs to key employees. The RSUs awarded under the 2012 RAP have an aggregate cash election dollar value of approximately $11.3 million and are subject to time-based vesting conditions that run through December 31, 2014. Generally, the number of RSUs awarded to each participant is equal to the quotient of (i) the Dollar Award Value, divided by (ii) $8.16, the value per share of Affinion Holdings’ common stock as of the grant date. Upon vesting of the RSUs, participants are able to settle the RSUs in shares of common stock or elect to receive cash in lieu of shares of common stock upon any of the three vesting dates for such RSUs. Due to the ability of the participants to settle their awards in cash, the Company accounts for these RSUs as a liability award.
A summary of restricted stock unit activity for the three months ended March 31, 2013 is presented below (number of restricted stock units in thousands):
Number of Restricted Stock Units | Weighted Average Grant Date Fair Value | |||||||
Outstanding restricted unvested awards at January 1, 2013 | 1,333 | $ | 8.18 | |||||
Granted | — | |||||||
Vested | (562 | ) | 8.18 | |||||
Forfeited | (42 | ) | 8.16 | |||||
|
| |||||||
Outstanding restricted unvested awards at March 31, 2013 | 729 | $ | 8.18 | |||||
|
| |||||||
Weighted average remaining contractual term (in years) | 1.0 |
18
Table of Contents
Based on the estimated fair value of the restricted stock units granted, stock-based compensation expense for the three months ended March 31, 2013 and 2012 was $1.4 million and $1.9 million, respectively. As of March 31, 2013, there was $5.7 million of unrecognized compensation cost related to the remaining vesting period of restricted stock units granted under the 2007 Plan. This cost will be recorded in future periods as stock-based compensation expense over a weighted average period of approximately 0.5 years.
9. | RELATED PARTY TRANSACTIONS |
Post-Closing Relationships with Cendant
Cendant has agreed to indemnify the Company, Affinion and the Company’s affiliates (collectively the “indemnified parties”) for breaches of representations, warranties and covenants made by Cendant, as well as for other specified matters, certain of which are described below. The Company and Affinion have agreed to indemnify Cendant for breaches of representations, warranties and covenants made in the purchase agreement, as well as for certain other specified matters. Generally, all parties’ indemnification obligations with respect to breaches of representations and warranties (except with respect to the matters described below) (i) are subject to a $0.1 million occurrence threshold, (ii) are not effective until the aggregate amount of losses suffered by the indemnified party exceeds $15.0 million (and then only for the amount of losses exceeding $15.0 million) and (iii) are limited to $275.1 million of recovery. Generally, subject to certain exceptions of greater duration, the parties’ indemnification obligations with respect to representations and warranties survived until April 15, 2007 with indemnification obligations related to covenants surviving until the applicable covenant has been fully performed.
In connection with the purchase agreement, Cendant agreed to specific indemnification obligations with respect to the matters described below.
Excluded Litigation. Cendant has agreed to fully indemnify the indemnified parties with respect to any pending or future litigation, arbitration, or other proceeding relating to accounting irregularities in the former CUC International, Inc. announced on April 15, 1998.
Certain Litigation and Compliance with Law Matters. Cendant has agreed to indemnify the indemnified parties up to specified amounts for: (a) breaches of its representations and warranties with respect to legal proceedings that (1) occur after the date of the purchase agreement, (2) relate to facts and circumstances related to the business of AGLLC or Affinion International Holdings Limited (“Affinion International”) and (3) constitute a breach or violation of its compliance with law representations and warranties and (b) breaches of its representations and warranties with respect to compliance with laws to the extent related to the business of AGLLC or Affinion International.
Cendant, the Company and Affinion have agreed that losses up to $15.0 million incurred with respect to these matters will be borne solely by the Company and losses in excess of $15.0 million will be shared by the parties in accordance with agreed upon allocations. The Company has the right at all times to control litigation related to shared losses and Cendant has consultation rights with respect to such litigation.
Prior to 2009, Cendant (i) distributed the equity interests it previously held in its hospitality services business (“Wyndham”) and its real estate services business (“Realogy”) to Cendant stockholders and (ii) sold its travel services business (“Travelport”) to a third party. Cendant continues as a re-named publicly traded company which owns the vehicle rental business (“Avis Budget,” together with Wyndham and Realogy, the “Cendant Entities”). Subject to certain exceptions, Wyndham and Realogy have agreed to share Cendant’s contingent and other liabilities (including its indemnity obligations to the Company described above and other liabilities to the Company in connection with the Apollo Transactions) in specified percentages. If any Cendant Entity defaults in its payment, when due, of any such liabilities, the remaining Cendant Entities are required to pay an equal portion of the amounts in default. Wyndham held a portion of the preferred stock issued in connection with the Apollo Transactions until the preferred stock was redeemed in 2011 and a portion of the warrants issued in connection with the Apollo Transactions, until the warrants expired in 2011, while Realogy was subsequently acquired by an affiliate of Apollo. Therefore, for the three months ended March 31, 2013 and 2012, only Realogy remains a related party.
Other Agreements
On October 17, 2005, Apollo entered into a consulting agreement with the Company for the provision of certain structuring and advisory services. The consulting agreement allows Apollo and its affiliates to provide certain advisory services for a period of twelve years or until Apollo owns less than 5% of the beneficial economic interests of the Company, whichever is earlier. The agreement could be terminated earlier by mutual consent. The Company was required to pay Apollo an annual fee of $2.0 million for these services commencing in 2006. On January 14, 2011, the Company and Apollo entered into an Amended and Restated Consulting Agreement (“Consulting Agreement”), pursuant to which Apollo and its affiliates will continue to provide Affinion with certain advisory services on substantially the same terms as the previous consulting agreement, except that the annual fee paid by Affinion increased to $2.6 million from $2.0 million, commencing January 1, 2012, with an additional one-time fee of $0.6 million which was
19
Table of Contents
paid in January 2011 in respect of calendar year 2011. The amounts expensed related to this consulting agreement were $0.7 million for each of the three months ended March 31, 2013 and 2012, which are included in general and administrative expenses in the accompanying unaudited condensed consolidated statement of comprehensive income. If a transaction is consummated involving a change of control or an initial public offering, then, in lieu of the annual consulting fee and subject to certain qualifications, Apollo may elect to receive a lump sum payment equal to the present value of all consulting fees payable through the end of the term of the consulting agreement.
In addition, the Company will be required to pay Apollo a transaction fee if it engages in any merger, acquisition or similar transaction. The Company will also indemnify Apollo and its affiliates and their directors, officers and representatives for potential losses relating to the services to be provided under the consulting agreement.
In July 2006, Apollo acquired one of the Company’s vendors, SOURCECORP Incorporated, that provides document and information services to the Company. The fees incurred for these services were $0.1 million and $0.3 million, respectively, for the three months ended March 31, 2013 and 2012, which is included in cost of revenues in the accompanying unaudited condensed consolidated statements of comprehensive income.
During the three months ended March 31, 2012, the Company purchased $1.1 million of gift cards from AMC Entertainment, Inc., a company previously owned by an affiliate of Apollo. The cost of the gift cards, which were utilized primarily for loyalty program fulfillment, is included as a contra-revenue in the consolidated statement of comprehensive income. As a result of the sale in 2012 of AMC Entertainment, Inc. by the affiliate of Apollo, AMC Entertainment, Inc. was not a related party during the three months ended March 31, 2013.
On January 28, 2010, the Company acquired an ownership interest of approximately 5%, subsequently reduced to 2.9%, in Alclear Holdings, LLC (“Alclear”) for $1.0 million. A family member of one of the Company’s directors controls and partially funded Alclear and serves as its chief executive officer. The Company provides support services to Alclear and recognized revenue of $0.3 million for each of the three months ended March 31, 2013 and 2012.
On January 14, 2011, in connection with the acquisition of Webloyalty, Mr. Richard J. Fernandes received warrants to purchases shares of Affinion Holdings’ common stock that were exercisable, in whole or in part, at any time between January 14, 2011 and May 12, 2012. The warrants expired on May 12, 2012 without being exercised
On April 9, 2012, Affinion declared, and on April 10, 2012, Affinion paid a dividend of $37.0 million to the Company, utilizing available cash on hand. The Company utilized the proceeds of the dividend to make future interest payments on its 11.625% senior notes.
10. | FINANCIAL INSTRUMENTS, DERIVATIVES AND FAIR VALUE MEASURES |
Interest Rate Swaps
In January 2009, Affinion entered into an interest rate swap effective February 21, 2011. The swap had a notional amount of $500.0 million and terminated on October 17, 2012. Under the swap, Affinion had agreed to pay a fixed rate of interest of 2.985%, payable on a quarterly basis with the first interest payment due on May 21, 2011, in exchange for receiving floating payments based on a three-month LIBOR on the notional amount for each applicable period.
All outstanding interest rate swaps were recorded at fair value. The changes in the fair value of the swaps, which were not designated as hedging instruments, are included in interest expense in the accompanying unaudited condensed consolidated statements of comprehensive income. For the three months ended March 31, 2012, the Company recorded interest expense, representing realized and unrealized gains and losses, of $0.9 million related to the interest rate swaps. There was no interest expense recorded during the three months ended March 31, 2013 related to the interest rate swaps.
As a matter of policy, the Company does not use derivatives for trading or speculative purposes.
The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity for the Company’s long-term debt as of March 31, 2013:
2013 | 2014 | 2015 | 2016 | 2017 | 2018 and Thereafter | Total | Fair Value At March 31, 2013 | |||||||||||||||||||||||||
(in millions) | ||||||||||||||||||||||||||||||||
Fixed rate debt | $ | 0.4 | $ | 0.4 | $ | 680.8 | $ | — | $ | — | $ | 475.0 | $ | 1,156.6 | $ | 893.4 | ||||||||||||||||
Average interest rate | 10.04 | % | 10.04 | % | 10.04 | % | 7.88 | % | 7.88 | % | 7.88 | % | ||||||||||||||||||||
Variable rate debt | $ | 8.4 | $ | 11.3 | $ | 11.2 | $ | 1,062.2 | $ | — | $ | — | $ | 1,093.1 | $ | 1,074.0 | ||||||||||||||||
Average interest rate(a) | 6.50 | % | 6.50 | % | 6.50 | % | 6.50 | % |
(a) | Average interest rate is based on rates in effect at March 31, 2013. |
20
Table of Contents
Foreign Currency Forward Contracts
On a limited basis the Company has entered into 30 day foreign currency forward contracts, and upon expiration of the contracts, entered into successive 30 day foreign currency forward contracts. The contracts have been entered into to mitigate the Company’s foreign currency exposures related to intercompany loans which are not expected to be repaid within the next twelve months and that are denominated in Euros and British pounds. At March 31, 2013, the Company had in place contracts to sell EUR 26.6 million and receive $33.9 million and to sell GBP 13.9 million and receive $21.0 million.
During the three months ended March 31, 2013 and 2012, the Company recognized a realized gain on the forward contracts of $2.6 million and a realized loss of $0.3 million, respectively. As of March 31, 2013, the Company had a $0.2 million unrealized loss on the foreign currency forward contracts.
Credit Risk and Exposure
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of receivables, profit-sharing receivables from insurance carriers, prepaid commissions and interest rate swaps. The Company manages such risk by evaluating the financial position and creditworthiness of such counterparties. As of March 31, 2013 and December 31, 2012, approximately $62.6 million and $55.7 million, respectively, of the profit-sharing receivable was due from one insurance carrier. Receivables and profit-sharing receivables from insurance carriers are from various marketing, insurance and business partners and the Company maintains an allowance for losses, based upon expected collectability. Commission advances are periodically evaluated as to recovery.
Fair Value
The Company determines the fair value of financial instruments as follows:
a. | Cash and Cash Equivalents, Restricted Cash, Receivables, Profit-Sharing Receivables from Insurance Carriers and Accounts Payable—Carrying amounts approximate fair value at March 31, 2013 and December 31, 2012 due to the short-term maturities of these assets and liabilities. |
b. | Long-Term Debt—The Company’s estimated fair value of its long-term fixed-rate debt at March 31, 2013 and December 31, 2012 is based upon available information for debt having similar terms and risks. The fair value of the publicly-traded debt is the published market price per unit multiplied by the number of units held or issued without consideration of transaction costs. The fair value of the non-publicly-traded debt, substantially all of which is variable-rate debt, is based on third party indicative valuations and estimates prepared by the Company after consideration of the creditworthiness of the counterparties. |
c. | Foreign Currency Forward Contracts—At March 31, 2013 and December 31, 2012, the Company’s estimated fair value of its foreign currency forward contracts is based upon available market information. The fair value of the foreign currency forward contracts is based on significant other observable inputs, adjusted for contract restrictions and other terms specific to the foreign currency forward contracts. The fair value has been determined after consideration of foreign currency exchange rates and the creditworthiness of the parties to the foreign currency forward contracts. The counterparty to the foreign currency forward contracts is a major financial institution. The Company does not expect any losses from non-performance by the counterparty. |
Current accounting guidance establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, giving the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. Level 1 inputs to a fair value measurement are quoted market prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability.
21
Table of Contents
There were no financial instruments measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012, other than foreign currency forward contracts. Such contracts have historically had a term of approximately thirty days and have been held to maturity. The fair value of the foreign currency forward contracts is measured based on significant observable inputs (Level 2).
The following table summarizes assets measured at fair value using Level 3 inputs on a nonrecurring basis subsequent to initial recognition:
Fair Value Measurements at December 31, 2012 | ||||||||||||||||||||
Fair Value at December 31, 2012 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Impairment Losses Year Ended December 31, 2012 | ||||||||||||||||
(in millions) | ||||||||||||||||||||
Goodwill | — | — | — | — | $ | (31.5 | ) | |||||||||||||
Intangible assets | $ | 2.1 | — | — | $ | 2.1 | (8.2 | ) | ||||||||||||
Equity investment | 0.7 | — | — | 0.7 | (1.0 | ) |
11. | SEGMENT INFORMATION |
Management evaluates the operating results of each of its reportable segments based upon several factors, of which the primary factors are revenue and “Segment EBITDA,” which the Company defines as income from operations before depreciation and amortization. The presentation of Segment EBITDA may not be comparable to similarly titled measures used by other companies.
The Segment EBITDA of the Company’s four reportable segments does not include general corporate expenses. General corporate expenses include costs and expenses that are of a general corporate nature or managed on a corporate basis, including primarily stock-based compensation expense and consulting fees paid to Apollo. General corporate expenses have been excluded from the presentation of the Segment EBITDA for the Company’s four reportable segments because they are not reported to the chief operating decision maker for purposes of allocating resources among operating segments or assessing operating segment performance. The accounting policies of the reportable segments are the same as those described in Note 2—Summary of Significant Accounting Policies in the Company’s Form 10-K for the year ended December 31, 2012.
22
Table of Contents
Net Revenues
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
(in millions) | ||||||||
Affinion North America | ||||||||
Membership products | $ | 143.7 | $ | 187.9 | ||||
Insurance and package products | 76.6 | 85.9 | ||||||
Loyalty products | 42.7 | 38.4 | ||||||
Eliminations | (0.5 | ) | (0.6 | ) | ||||
|
|
|
| |||||
Total North America | 262.5 | 311.6 | ||||||
Affinion International | ||||||||
International products | 84.9 | 70.2 | ||||||
|
|
|
| |||||
$ | 347.4 | $ | 381.8 | |||||
|
|
|
|
Segment EBITDA
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
(in millions) | ||||||||
Affinion North America | ||||||||
Membership products | $ | 23.7 | $ | 45.2 | ||||
Insurance and package products | 29.2 | 31.3 | ||||||
Loyalty products | 16.7 | 12.4 | ||||||
|
|
|
| |||||
Total North America | 69.6 | 88.9 | ||||||
Affinion International | ||||||||
International products | 5.8 | 1.2 | ||||||
|
|
|
| |||||
Total products | 75.4 | 90.1 | ||||||
Corporate | (4.1 | ) | (3.3 | ) | ||||
|
|
|
| |||||
$ | 71.3 | $ | 86.8 | |||||
|
|
|
|
For the Three Months Ended | ||||||||
March 31, 2013 | March 31, 2012 | |||||||
(in millions) | ||||||||
Segment EBITDA | $ | 71.3 | $ | 86.8 | ||||
Depreciation and amortization | (29.6 | ) | (50.1 | ) | ||||
|
|
|
| |||||
Income from operations | $ | 41.7 | $ | 36.7 | ||||
|
|
|
|
23
Table of Contents
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
This Quarterly Report on Form 10-Q (this “Form 10-Q”) is prepared by Affinion Group Holdings, Inc. Unless otherwise indicated or the context otherwise requires, in this Form 10-Q all references to “Affinion Holdings,” the “Company,” “we,” “our” and “us” refer to Affinion Group Holdings, Inc. and its subsidiaries on a consolidated basis. All references to “Affinion” refer to our wholly-owned subsidiary, Affinion Group, Inc.
The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our audited consolidated financial statements as of December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010, included in our Annual Report on Form 10-K for the year ended December 31, 2012 (the “Form 10-K”) and with the unaudited condensed consolidated financial statements and related notes thereto presented in this Form 10-Q.
Disclosure Regarding Forward-Looking Statements
Our disclosure and analysis in this Form 10-Q may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Private Securities Litigation Reform Act of 1995, that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. All statements other than statements of historical facts included in this Form 10-Q that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements.
These forward-looking statements are largely based on our expectations and beliefs concerning future events, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control.
Although we believe our estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In addition, management’s assumptions about future events may prove to be inaccurate. Management cautions all readers that the forward-looking statements contained in this Form 10-Q are not guarantees of future performance, and we cannot assure any reader that those statements will be realized or the forward-looking events and circumstances will occur. Actual results may differ materially from those anticipated or implied in the forward-looking statements due to the factors listed under “Item 1A. Risk Factors” in our Form 10-K and this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section, or MD&A. All forward-looking statements speak only as of the date of this Form 10-Q. We do not intend to publicly update or revise any forward-looking statements as a result of new information, future events or otherwise, except as required by law. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.
Introduction
The MD&A is provided as a supplement to the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere herein to help provide an understanding of our financial condition, results of our operations and changes in our financial condition. The MD&A is organized as follows:
• | Overview. This section provides a general description of our business and operating segments, as well as recent developments that we believe are important in understanding our results of operations and financial condition and in anticipating future trends. |
• | Results of operations. This section provides an analysis of our results of operations for the three months ended March 31, 2013 and 2012. This analysis is presented on both a consolidated basis and on an operating segment basis. |
• | Financial condition, liquidity and capital resources. This section provides an analysis of our cash flows for the three months ended March 31, 2013 and 2012 and our financial condition as of March 31, 2013, as well as a discussion of our liquidity and capital resources. |
• | Critical accounting policies. This section discusses certain significant accounting policies considered to be important to our financial condition and results of operations and which require significant judgment and estimates on the part of management in their application. In addition, we refer you to our audited consolidated financial statements as of December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010, included in the Form 10-K for a summary of our significant accounting policies. |
24
Table of Contents
Overview
Description of Business
We are a global leader in the designing, marketing and servicing of comprehensive customer engagement and loyalty solutions that enhance and extend the relationship of millions of consumers with many of the largest and most respected companies in the world. We generally partner with these leading companies in two ways: 1) by developing and supporting programs that are natural extensions of our partner companies’ brand image and that provide valuable services to their end-customers, and 2) by providing the back-end technological support and redemption services for points-based loyalty programs. Using our expertise in customer engagement, product development, creative design and data-driven targeted marketing, we develop and market programs and services that enable the companies we partner with to generate significant, high-margin incremental revenue, enhance our partners’ brand among targeted consumers as well as strengthen and enhance the loyalty of their customer relationships. The enhanced loyalty can lead to increased acquisition of new customers, longer retention of existing customers, improved customer satisfaction rates, and greater use of other services provided by such companies. We refer to the leading companies that we work with to provide customer engagement and loyalty solutions as our marketing partners. We refer to the consumers with whom we provide services directly under a contractual relationship as subscribers, insureds or members. We refer to those consumers that we service on behalf of a third party, such as one of our marketing partners, and with whom we have a contractual relationship as end customers.
We utilize our substantial expertise in a variety of direct engagement media to market valuable products and services to the customers of our marketing partners on a highly targeted, campaign basis. The selection of the media employed in a campaign corresponds to the preferences and expectations the targeted customers have demonstrated for transacting with our marketing partners, as we believe this optimizes response, thereby improving the efficiency of our marketing investment. Accordingly, we maintain significant capabilities to market through direct mail, point-of-sale, direct response television, the internet, inbound and outbound telephony and voice response unit marketing, as well as other media as needed.
We design customer engagement and loyalty solutions with an attractive suite of benefits and ease of usage that we believe are likely to interest and engage consumers based on their needs and interests. For example, we provide discount travel services, credit monitoring and identity-theft resolution, AD&D insurance, roadside assistance, and various checking account and credit card enhancement services, loyalty program design and management, as well as disaggregated loyalty points redemptions for gift cards, travel and merchandise, as well as other products and services.
We believe our portfolio of the products and services that are embedded in our engagement solutions is the broadest in the industry. Our scale, combined with the industry’s largest proprietary database, proven marketing techniques and strong marketing partner relationships developed over our 40 year operating history, position us to deliver consistent results in a variety of market conditions.
As of December 31, 2012, we had approximately 65.3 million subscribers and end-customers enrolled in our membership, insurance and package programs worldwide and approximately 154 million customers who received credit or debit card enhancement services or loyalty points-based management services.
We organize our business into two operating units:
• | Affinion North America. Affinion North America comprises our Membership, Insurance and Package, and Loyalty customer engagement businesses in North America. |
• | Membership Products. We design, implement and market subscription programs that provide our members with personal protection benefits and value-added services including credit monitoring and identity-theft resolution services as well as access to a variety of discounts and shop-at-home conveniences in such areas as concierge services, retail merchandise, travel, automotive and home improvement. |
• | Insurance and Package Products. We market AD&D and other insurance programs and design and provide checking account enhancement programs to financial institutions. These programs allow financial institutions to bundle valuable discounts, protection and other benefits with a standard checking account and offer these packages to customers for an additional monthly fee. |
• | Loyalty Products. We design, implement and administer points-based loyalty programs and, as of December 31, 2012, managed programs representing an aggregate estimated redemption value of approximately $4.5 billion for financial, travel, auto and other companies. We provide our clients with solutions that meet the most popular redemption options desired by their program points holders, including travel services, gift cards, cash back and merchandise, and, in 2012, we facilitated $2.3 billion in redemption volume. We also provide enhancement benefits to major financial institutions in connection with their credit and debit card programs. In addition, we provide and manage turnkey travel services that are sold on a private label basis to provide our clients’ customers with direct access to our proprietary travel platform. A marketing partner typically engages us on a fee-for-service contractual basis, where we generate revenue in connection with the volume of redemption transactions. |
25
Table of Contents
• | Affinion International. Affinion International comprises our Membership, Package and Loyalty customer engagement businesses outside North America. We have not offered AD&D or related insurance programs outside North America since 2000. We expect to leverage our current international operational platform to expand our range of products and services, develop new marketing partner relationships in various industries and grow our geographical footprint. Most recently, we have expanded our footprint into Brazil by launching business operations and into Turkey through the acquisition of existing marketing capabilities. |
We offer our products and services through both retail and wholesale arrangements with our marketing partners as well as through direct-to-consumer marketing. Currently, we primarily provide wholesale services and benefits derived from our credit card registration, credit monitoring and identity-theft resolution products. In the majority of our retail arrangements, we incur the marketing solicitation expenses to acquire new customers for our subscription-based membership, insurance and package enhancement products with the objective of building a base of highly profitable and predictable recurring future revenue streams and cash flows. For our membership, insurance and package enhancement products, these upfront marketing costs are expensed when the costs are incurred in support of a launched campaign.
Our membership programs are offered under a variety of terms and conditions. Prospective members are usually offered incentives (e.g. free credit reports or other premiums) and one to three month risk-free trial periods to encourage them to evaluate and use the benefits of membership before the first billing period takes effect. We do not recognize any revenue during the trial period and expense the cost of all incentives and program benefits and servicing costs as incurred.
Customers of our membership programs typically pay their subscription fees either annually or monthly. Our membership products may have significant timing differences between the receipt of membership fees for annual members and revenue recognition. Historically, memberships were offered primarily under full money back terms whereby a member could receive a full refund upon cancellation at any time during the current membership term. These revenues were recognized upon completion of the membership term when they were no longer refundable. Depending on the length of the trial period, this revenue may not have been recognized for up to 16 months after the related marketing spend is incurred and expensed. Currently, annual memberships are primarily renewed under pro-rata arrangements in which the member is entitled to a prorated refund for the unused portion of their membership term. This allows us to recognize revenue ratably over the annual membership term. Upon completion of the subscription term, the membership renews under generally the same billing terms in which it originated. Given that we had historically offered a significant amount of subscriptions offering annual terms, our existing base continues to reflect a blend of both monthly and annual terms, and will continue doing so for as long as a substantial percentage of the annual subscribers renew. However, the majority of our recent solicitation activity has been for subscriptions offering monthly terms, and during the three months ended March 31, 2013 and the year ended December 31, 2012, in excess of 95% of our domestic new member and end-customer enrollments were in monthly payment programs. Revenue is recognized monthly under both annual pro rata and monthly memberships, allowing for a better matching of revenues and related servicing and benefit costs when compared to annual full money back memberships.
When marketing with a marketing partner, we generally utilize the brand names and customer contacts of the marketing partner in our marketing campaigns. We usually compensate our marketing partners either through commissions based on revenues we receive from members (which we expense in proportion to the revenue we recognize) or up-front marketing payments, commonly referred to as “bounties” (which we expense when incurred). In addition, we can enter into arrangements with certain marketing partners where we pay the marketing partners advance commissions which provide the potential for recovery from the marketing partners if certain targets are not achieved. These payments are capitalized and amortized over the expected life of the acquired members. The commission rates that we pay to our marketing partners differ depending on the arrangement we have with the particular marketing partner and the type of media we utilize for a given marketing campaign.
In a direct-to-consumer campaign, we invest in a variety of media to generate consumer awareness of our programs and services and stimulate responses from our targeted markets. The media channels we employ in direct-to-consumer included television advertising as well as Internet marketing, such as search engine optimization and related techniques. When marketing directly to the consumer, we generally use our proprietary brands and avoid incurring any commission expense.
We serve as an agent and third-party administrator on behalf of a variety of underwriters for the marketing of AD&D and our other insurance products. Free trial periods and incentives are generally not offered with our insurance programs. Insurance program participants typically pay their insurance premiums either monthly or quarterly. We earn revenue in the form of commissions collected on behalf of the insurance carriers and participate in profit-sharing relationships with the carriers that underwrite the insurance policies that we market, where profit is measured by the excess amount of premium remitted to the carrier less the cost for claim activities and any related expenses. Our estimated share of profits from these arrangements is reflected as profit-sharing receivables from insurance carriers on the accompanying audited consolidated balance sheets and any changes in estimated profit sharing in connection with the actual claims activities are periodically recorded as an adjustment to net revenue. Insurance revenues are recognized ratably over the insurance period for which a policy is in effect and there are no significant differences between cash flows and related revenue recognition. Revenue from insurance programs is reported net of insurance costs in the accompanying audited consolidated statements of operations.
26
Table of Contents
In our wholesale arrangements, we provide our products and services as well as customer service and fulfillment related to such products and services to support programs that our marketing partners offer to their customers. In such arrangements, our marketing partners are typically responsible for customer acquisition, retention and collection and generally pay us one-time implementation fees and on-going monthly service fees based on the number of members enrolled in their programs. Implementation fees are recognized ratably over the contract period while monthly service fees are recognized in the month earned. Wholesale revenues also include revenues from transactional activities associated with our programs, such as the sales of additional credit reports, discount shopping or travel purchases by members. The revenues from such transactional activities are recognized in the month earned.
We have a highly variable-cost structure because the majority of our expenses are either discretionary in nature or tied directly to the generation of revenue. In addition, we have achieved meaningful operating efficiencies by combining similar functions and processes, consolidating facilities and outsourcing a significant portion of our call center and other back-office processing, particularly with respect to previously acquired businesses. This added flexibility better enables us to deploy our discretionary marketing expenditures globally across our operations to maximize returns.
Factors Affecting Results of Operations and Financial Condition
Competitive Environment
As a leader in the affinity direct marketing industry, we compete with many other organizations, including certain of our marketing partners as well as other benefit providers, to obtain a share of the end consumer’s spending in each of our respective product categories. As an affinity direct marketer, we derive our leads from a marketing partner’s contacts, which our competitors also seek access to, and we must therefore generate sufficient earnings per lead for our marketing partners to compete effectively for access to their end customers.
As direct-to-consumer marketers, we compete with any company who offers comparable benefits and services to what we market from own product portfolio.
We compete with companies of varying size, financial strength and availability of resources. Our competitors include marketing solutions providers, financial institutions, insurance companies, consumer goods companies, internet companies and others, as well as direct marketers offering similar programs. Some of our competitors are larger than we are and are able to deploy more resources in their pursuit of the limited target market for our products.
We expect these competitive environments to continue in the foreseeable future.
Acquisitions
On July 14, 2011, the Company and Affinion entered into an Agreement and Plan of Merger to acquire Prospectiv Direct, Inc. (“Prospectiv”), an online performance marketer and operator of one of the leading daily deal websites in the United States. On August 1, 2011, the merger was consummated and, as a result, the Company acquired all of the capital stock of Prospectiv for an initial cash purchase price of $31.8 million. If Prospectiv had achieved certain performance targets over the 30 month period that commenced on July 1, 2011, the former equity holders would have been entitled to additional consideration in the form of an earn-out of up to $45.0 million and certain members of Prospectiv’s management would have been entitled to receive additional compensation related to their continued employment of up to $10.0 million. Such additional consideration and compensation was to be settled in some combination of cash and shares of Affinion Holdings’ common stock.
In late March of 2012, Prospectiv implemented a reduction in force and revised its growth plans for 2012 and 2013. Based on these revised growth plans, the Company concluded that it does not expect to pay any additional consideration in the form of an earn-out or additional compensation based on achievement of performance targets. Accordingly, during the three months ended March 31, 2012, the Company reversed certain accruals for additional consideration recorded as part of the Prospectiv acquisition and additional compensation as the Company will not be able to achieve the growth originally planned for these years due to market conditions. The reduction of the accruals for additional consideration and additional compensation reduced general and administrative expense for the year ended December 31, 2012 by $14.6 million and $1.1 million, respectively. In addition, during the three months ended September 30, 2012, the Company entered into a settlement agreement with the former equity holders of Prospectiv which resulted in a $0.7 million reduction of the initial purchase price and released the Company from any future claims for additional consideration and for future compensation based on achievement of the performance targets. The reduction in the initial purchase price was included in general and administrative expenses in the accompanying statement of comprehensive income for the year ended December 31, 2012.
The Company concluded that the revisions made to the Prospectiv forecast, as well as other marketplace events, represented an indication of potential impairment of Prospectiv’s goodwill and intangible assets. As a result, during the three months ended June 30, 2012, the Company performed an interim impairment test of the goodwill for Prospectiv, which is a separate reporting unit within the Membership Products reporting segment, as of April 1, 2012. Based on the interim impairment test, the Company recorded an impairment loss during the three months ended June 30, 2012 of $31.5 million, representing all of the goodwill ascribed to Prospectiv at the date of acquisition. During the three months ended June 30, 2012, the Company also performed an impairment test related to the intangible assets of Prospectiv as of April 1, 2012 and, based on the impairment test, recorded an impairment loss related to the Prospectiv intangible assets of $8.2 million.
27
Table of Contents
On November 14, 2012, the Company entered into, and consummated, a Share Sale and Purchase Agreement (“Agreement”) that resulted in the acquisition of Boyner Bireysel Urunler Satis ve Pazarlama A.S (“Back-Up”), a Turkish provider of assistance and consultancy services to its members, and a sister company, Bofis Turizm ve Ticaret A.S. (“Travel”), a Turkish travel agency. In accordance with the Agreement, on November 14, 2012, the Company acquired 90% of the outstanding capital stock of Back-Up and 99.99% of the outstanding capital stock of Travel for an upfront cash payment of approximately $12.5 million and contingent consideration payable ratably on each of the first three anniversaries of the acquisition date aggregating approximately $8.4 million.
Back-Up and Travel were owned by Turkey’s largest retail group and the Company believes that Back-Up’s and Travel’s assistance and concierge service model fits well with the Company’s global product offerings. The acquisition will enable the Company to expand into Turkey, which the Company deems a key market, given both its size as well as the attractive demographics of its population, and enables the expansion of the Company’s product offerings to a new customer base.
Financial Industry Trends
Historically, financial institutions have represented a significant majority of our marketing partner base. Consumer banking is a highly regulated industry, with various federal, state and international authorities governing various aspects of the marketing and servicing of the products we offer through our financial institution partners.
For instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) mandates the most wide-ranging overhaul of financial industry regulation in decades. Dodd-Frank was signed into law on July 21, 2010. Dodd-Frank provides a regulatory framework and requires that regulators draft, review and approve, and implement numerous regulations and conduct studies that are likely to lead to more regulations. As part of this, Dodd-Frank created the Consumer Financial Protection Bureau (the “CFPB”) that became operational on July 21, 2011, and has been given authority to regulate all consumer financial products sold by banks and non-bank companies. These regulations have imposed additional reporting, supervisory, and regulatory requirements on our financial institution marketing partners which has adversely affected our business, financial condition and results of operations. In addition, even an inadvertent failure of our financial institution marketing partners to comply with these laws and regulations, as well as rapidly evolving social expectations of corporate fairness, could adversely affect our business or our reputation going forward. Some of our marketing partners have become involved in governmental inquiries that include our products or marketing practices. As a result, certain financial institution marketing partners have, and others could, delay or cease marketing with us, terminate their agreements with us, require us to cease providing services to members or end-consumers, or require changes to our products or services to consumers that could also have a material adverse effect on our business. Partially as a result of these factors, we have recently experienced a decline in our domestic membership customer base and domestic membership revenues, and we anticipate this trend will continue in the near future.
In certain circumstances, our financial marketing partners have sought to source and market their own in-house programs, most notably programs that are analogous to our credit card registration, credit monitoring and identity-theft resolution services. As we have sought to maintain our market share in these areas and to continue these programs with our marketing partners, in some circumstances, we have shifted from a retail marketing arrangement to a wholesale arrangement which results in lower net revenue, but unlike our retail arrangement, has no related commission expense, thereby preserving our ability to earn a suitable rate of return on the campaign. During periods of increased interest from our marketing partners for wholesale activity, partially as a result of this trend, we have experienced a revenue reduction in our membership business.
Internationally, our package products have been primarily offered by some of the largest financial institutions in Europe. As these banks attempt to increase their own net revenues and margins, we have experienced significant price reductions when our agreements come up for renewal from what we had previously been able to charge these institutions for our programs. We expect this pricing pressure on our international package offerings to continue in the future.
Direct-to-Consumer
We are allocating an increasing percentage of our domestic marketing investment to the direct-to-consumer channel. We have tested various direct-to-consumer media and we believe we will be able to achieve returns on our investments that are comparable to, or in certain instances better than, our traditional channels.
Regulatory Environment
We are subject to federal and state regulation as well as regulation by foreign authorities in other jurisdictions. Certain laws and regulations that govern our operations include: federal, state and foreign marketing and consumer protection laws and regulations; federal, state and foreign privacy and data protection laws and regulations; and federal, state and foreign insurance and insurance mediation laws and regulations. Federal regulations are primarily enforced by the FTC, the FCC and the CFPB. State regulations are primarily enforced by individual state attorneys general. Foreign regulations are enforced by a number of regulatory bodies in the relevant jurisdictions.
28
Table of Contents
These regulations primarily impact the means we use to market our programs, which can reduce the acceptance rates of our solicitation efforts, and impact our ability to obtain information from our members and end-customers. In addition, new and contemplated regulations enacted by, or marketing partner settlement agreements or consent orders with, the CFPB could impose additional reporting, supervisory and regulatory requirements on, as well as result in inquiries of, us and our marketing partners that could delay marketing campaigns with certain marketing partners, impact the services and products we provide to consumers, and adversely affect our business, financial condition and results of operations.
We incur significant costs to ensure compliance with these regulations; however, we are party to lawsuits, including class action lawsuits, and state attorney general investigations involving our business practices which also increase our costs of doing business. See Note 7 to our unaudited condensed consolidated financial statements in “Item 1. Financial Statements.”
Seasonality
Historically, seasonality has not had a significant impact on our business. Our revenues are more affected by the timing of marketing programs that can change from year to year depending on the opportunities available and pursued. More recently, in connection with the growth in our loyalty business, we have experienced increasing seasonality in the timing of our cash flows, particularly with respect to working capital. This has been due primarily to the consumer’s increasing acceptance and use of certain categories for points redemptions, such as travel services and gift cards. These categories typically present a delay from the time we incur a cash outlay to provision the redemption until we are reimbursed by the client for the activity, and in certain instances, these delays may extend across multiple reporting periods. Redemptions for some categories, such as gift cards, have been weighted more heavily to the end of the year due to consumers’ increasing usage of points in connection with seasonal gift giving.
Results of Operations
Supplemental Data
We manage our business using a portfolio approach, meaning that we allocate and reallocate our marketing investments in the ongoing pursuit of the highest and best available returns, allocating our resources to whichever products, geographies and programs offer the best opportunities. With the globalization of our clients, the continued evolution of our programs and services and the ongoing refinement and execution of our marketing allocation strategy, we have developed the following table that we believe captures the way we look at the businesses (subscriber and insured amounts in thousands except per average subscriber and insured amounts).
Three Months Ended March 31, | ||||||||
2013 | 2012 | |||||||
Global Average Subscribers, excluding Basic Insureds | 42,579 | 45,728 | ||||||
Annualized Net Revenue Per Global Average Subscriber, excluding Basic Insureds(1) | $ | 28.71 | $ | 29.86 | ||||
Global Membership Subscribers | ||||||||
Average Global Retail Subscribers(2) | 9,597 | 11,119 | ||||||
Annualized Net Revenue Per Global Average Subscriber(1) | $ | 78.90 | $ | 78.85 | ||||
Global Package Subscribers and Wholesale | ||||||||
Average Global Package Subscribers and Wholesale(2) | 28,947 | 30,387 | ||||||
Annualized Net Revenue Per Global Average Package and Wholesale Subscriber(1) | $ | 7.45 | $ | 7.00 | ||||
Global Insureds | ||||||||
Average Supplemental Insureds(2) | 4,035 | 4,222 | ||||||
Annualized Net Revenue Per Supplemental Insured(1) | $ | 61.85 | $ | 65.30 | ||||
Global Average Subscribers, including Basic Insureds | 63,787 | 68,074 |
(1) | Annualized Net Revenue Per Global Average Subscriber and Supplemental Insured are all calculated by taking the revenues as reported for the period and dividing it by the average subscribers or insureds, as applicable, for the period. Quarterly periods are then multiplied by four to annualize this amount for comparative purposes. Upon cancellation of a subscriber or an insured, as applicable, the subscriber’s or insured’s, as applicable, revenues are no longer recognized in the calculation. |
(2) | Average Global Subscribers and Average Supplemental Insureds for the period are all calculated by determining the average subscribers or insureds, as applicable, for each month in the period (adding the number of subscribers or insureds, as applicable, at the beginning of the month with the number of subscribers or insureds, as applicable, at the end of the month and dividing that total by two) and then averaging that result for the period. A subscriber’s or insured’s, as applicable, account is added or removed in the period in which the subscriber or insured, as applicable, has joined or cancelled. |
29
Table of Contents
Wholesale members include end-customers where we typically receive a monthly service fee to support programs offered by our marketing partners. Certain programs historically offered as retail arrangements have switched to wholesale arrangements with lower annualized price points and no commission expense.
Basic insureds typically receive $1,000 of AD&D coverage at no cost to the consumer since the marketing partner pays the cost of this coverage. Supplemental insureds are customers who have elected to pay premiums for higher levels of coverage.
Segment EBITDA
Segment EBITDA consists of income from operations before depreciation and amortization. Segment EBITDA is the measure management uses to evaluate segment performance, and we present Segment EBITDA to enhance your understanding of our operating performance. We use Segment EBITDA as one criterion for evaluating our performance relative to that of our peers. We believe that Segment EBITDA is an operating performance measure, and not a liquidity measure, that provides investors and analysts with a measure of operating results unaffected by differences in capital structures, capital investment cycles and ages of related assets among otherwise comparable companies. However, Segment EBITDA is not a measurement of financial performance under accounting principles generally accepted in the United States (“U.S. GAAP”), and Segment EBITDA may not be comparable to similarly titled measures of other companies. You should not consider Segment EBITDA as an alternative to operating or net income determined in accordance with U.S. GAAP, as an indicator of operating performance or as an alternative to cash flows from operating activities determined in accordance with U.S. GAAP, or as an indicator of cash flows, or as a measure of liquidity.
Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012
The following table summarizes our consolidated results of operations for the three months ended March 31, 2013 and 2012:
Three Months Ended March 31, 2013 | Three Months Ended March 31, 2012 | Increase (Decrease) | ||||||||||
Net revenues | $ | 347.4 | $ | 381.8 | $ | (34.4 | ) | |||||
|
|
|
|
|
| |||||||
Expenses: | ||||||||||||
Cost of revenues, exclusive of depreciation and amortization shown separately below: | ||||||||||||
Marketing and commissions | 117.7 | 154.8 | (37.1 | ) | ||||||||
Operating costs | 116.2 | 118.1 | (1.9 | ) | ||||||||
General and administrative | 42.2 | 22.1 | 20.1 | |||||||||
Depreciation and amortization | 29.6 | 50.1 | (20.5 | ) | ||||||||
|
|
|
|
|
| |||||||
Total expenses | 305.7 | 345.1 | (39.4 | ) | ||||||||
|
|
|
|
|
| |||||||
Income from operations | 41.7 | 36.7 | 5.0 | |||||||||
Interest income | 0.1 | 0.3 | (0.2 | ) | ||||||||
Interest expense | (51.4 | ) | (47.6 | ) | (3.8 | ) | ||||||
Other income, net | 0.1 | 0.1 | — | |||||||||
|
|
|
|
|
| |||||||
Loss before income taxes and non-controlling interest | (9.5 | ) | (10.5 | ) | 1.0 | |||||||
Income tax expense | (5.1 | ) | (2.7 | ) | (2.4 | ) | ||||||
|
|
|
|
|
| |||||||
Net loss | (14.6 | ) | (13.2 | ) | (1.4 | ) | ||||||
Less: net loss (income) attributable to non-controlling interest | 0.1 | (0.2 | ) | 0.3 | ||||||||
|
|
|
|
|
| |||||||
Net loss attributable to Affinion Group Holdings, Inc. | $ | (14.5 | ) | $ | (13.4 | ) | $ | (1.1 | ) | |||
|
|
|
|
|
|
Summary of Operating Results for the Three Months Ended March 31, 2013
The following is a summary of changes affecting our operating results for the three months ended March 31, 2013.
Net revenues decreased $34.4 million, or 9.0%, for the three months ended March 31, 2013 as compared to the same period of the prior year. Net revenues in our North American units decreased $49.1 million primarily from lower retail revenues from a decline in volumes in our Membership business and lower revenue in our Insurance and Package business from a higher cost of insurance and was partially offset by higher revenue from growth with existing clients in our Loyalty business. International net revenues increased by $14.7 million primarily from higher retail membership revenue from increased online joins.
30
Table of Contents
Segment EBITDA decreased $15.5 million as the impact of the lower net revenues and higher general and administrative costs was partially offset by lower marketing and commissions. The higher general and administrative costs include $14.6 million from the absence in 2013 of a reversal of a liability in 2012 in connection with potential earn-out payments related to the Prospectiv acquisition.
Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012
The following section provides an overview of our consolidated results of operations for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.
Net Revenues. During the three months ended March 31, 2013 we reported net revenues of $347.4 million, a decrease of $34.4 million, or 9.0%, as compared to net revenues of $381.8 million in the comparable period of 2012. Net revenues of our Membership Products decreased $44.2 million primarily due to a decline in retail member volumes related to the regulatory challenges facing large financial institution marketing partners with respect to new marketing campaign launches. Revenue also declined from the continued, but anticipated, attrition of the domestic member base of Webloyalty and from lower volumes from certain fee-for-service wholesale arrangements. Insurance and Package revenues decreased $9.3 million primarily due to a higher cost of insurance from higher claims experience and lower package revenues primarily due to lower average package members. Loyalty Products net revenues increased $4.3 million which was primarily attributable to increased revenues from growth with existing clients. International Products net revenues increased $14.7 million primarily from higher retail membership revenue in our online channel and our recently acquired concierge business in Turkey.
Marketing and Commissions Expense. Marketing and commissions expense decreased by $37.1 million, or 24.0%, to $117.7 million for the three months ended March 31, 2013 from $154.8 million for the three months ended March 31, 2012. Marketing and commissions expense decreased $32.0 million in our Membership business primarily due to fewer marketing opportunities with our large financial institution marketing partners and lower commissions from the reduction in the member base.
Operating Costs. Operating costs decreased by $1.9 million, or 1.6%, to $116.2 million for the three months ended March 31, 2013 from $118.1 million for the three months ended March 31, 2012. Product and servicing costs decreased $6.8 million in our Membership business primarily due to the reduction in the member base while costs increased $5.0 million in our International business in response to the higher net revenues.
General and Administrative Expense. General and administrative expense increased by $20.1 million, or 91.0%, to $42.2 million for the three months ended March 31, 2013 from $22.1 million for the three months ended March 31, 2012 primarily due to the absence in 2013 of a reversal of a liability in 2012 of $14.6 million in connection with potential earn-out payments related to the Prospectiv acquisition in our Membership business.
Depreciation and Amortization Expense. Depreciation and amortization expense decreased by $20.5 million for the three months ended March 31, 2013 to $29.6 million from $50.1 million for the three months ended March 31, 2012, primarily from recording $4.6 million less amortization expense in 2013 as compared to 2012 related to intangible assets acquired in the Webloyalty acquisition, principally member relationships, and lower amortization of $13.9 million on the intangible assets acquired in connection with the Company’s acquisition of the Cendant Marketing Services Division (the “Apollo Transactions”) as the majority of those intangibles are amortized on an accelerated basis. This amortization expense is based upon an allocation of values to intangible assets and is being amortized over lives ranging from 3 years to 15 years.
Interest Expense. Interest expense increased by $3.8 million, or 8.0%, to $51.4 million for the three months ended March 31, 2013 from $47.6 million for the three months ended March 31, 2012, primarily due to higher interest accrued on Affinion’s term loan as a result of the amendment to the Affinion Credit Facility in the fourth quarter of 2012 which increased the interest rates on LIBOR and base rate loans.
Income Tax Expense. Income tax expense increased by $2.4 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012, primarily due to an increase in the deferred federal and state tax liabilities and an increase of the foreign current and deferred tax liabilities for the three months ended March 31, 2013, partially offset by a decrease in the current state tax liabilities for the same period.
Our effective income tax rates for the three months ended March 31, 2013 and 2012 were (54.1)% and (25.9)%, respectively. The difference in the effective tax rates for the three months ended March 31, 2013 and 2012 is primarily a result of the decrease in loss before income taxes and non-controlling interest of $10.5 million for the three months ended March 31, 2012 to $9.5 million for the three months ended March 31, 2013 and an increase in the income tax provision from $2.7 million for the three months ended March 31, 2012 to $5.1 million for the three months ended March 31, 2013. Our tax rate is affected by recurring items, such as tax rates in foreign jurisdictions and the relative amount of income it earns in those jurisdictions. It is also affected by discrete items that may occur in any given year, but are not consistent from year to year. In addition to state and foreign income taxes and related foreign tax credits, the requirement to maintain valuation allowances had the most significant impact on the difference between our effective tax rate and the statutory U.S. federal income tax rate of 35%.
31
Table of Contents
Operating Segment Results
Net revenues and Segment EBITDA by operating segment are as follows:
Three Months Ended March 31, | ||||||||||||||||||||||||
Net Revenues | Segment EBITDA(1) | |||||||||||||||||||||||
2013 | 2012 | Increase (Decrease) | 2013 | 2012 | Increase (Decrease) | |||||||||||||||||||
(in millions) | ||||||||||||||||||||||||
Affinion North America | ||||||||||||||||||||||||
Membership Products | $ | 143.7 | $ | 187.9 | $ | (44.2 | ) | $ | 23.7 | $ | 45.2 | $ | (21.5 | ) | ||||||||||
Insurance and Package Products | 76.6 | 85.9 | (9.3 | ) | 29.2 | 31.3 | (2.1 | ) | ||||||||||||||||
Loyalty Products | 42.7 | 38.4 | 4.3 | 16.7 | 12.4 | 4.3 | ||||||||||||||||||
Eliminations | (0.5 | ) | (0.6 | ) | 0.1 | — | — | — | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total North America | 262.5 | 311.6 | (49.1 | ) | 69.6 | 88.9 | (19.3 | ) | ||||||||||||||||
Affinion International | ||||||||||||||||||||||||
International Products | 84.9 | 70.2 | 14.7 | 5.8 | 1.2 | 4.6 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total products | 347.4 | 381.8 | (34.4 | ) | 75.4 | 90.1 | (14.7 | ) | ||||||||||||||||
Corporate | — | — | — | (4.1 | ) | (3.3 | ) | (0.8 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total | $ | 347.4 | $ | 381.8 | $ | (34.4 | ) | 71.3 | 86.8 | (15.5 | ) | |||||||||||||
|
|
|
|
|
| |||||||||||||||||||
Depreciation and amortization | (29.6 | ) | (50.1 | ) | 20.5 | |||||||||||||||||||
|
|
|
|
|
| |||||||||||||||||||
Income (loss) from operations | $ | 41.7 | $ | 36.7 | $ | 5.0 | ||||||||||||||||||
|
|
|
|
|
|
(1) | See Segment EBITDA above and Note 11 to the unaudited condensed consolidated financial statements for a discussion of Segment EBITDA and a reconciliation of Segment EBITDA to income from operations. |
Affinion North America
Membership Products. Membership Products net revenues decreased by $44.2 million, or 23.5%, to $143.7 million for the three months ended March 31, 2013 as compared to $187.9 million for the three months ended March 31, 2012. Net revenues decreased primarily due to a decline in retail member volumes related to the regulatory challenges facing large financial institution marketing partners with respect to new marketing campaign launches and from the continued, but anticipated, attrition of the domestic member base of Webloyalty. Revenue also declined from lower volumes in certain fee-for-service wholesale arrangements.
Segment EBITDA decreased by $21.5 million, or 47.6%, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Segment EBITDA decreased as the impact of the lower net revenues of $44.2 million was partially offset by lower marketing and commissions of $32.0 million and lower operating costs of $6.8 million. The lower marketing and commissions were primarily the result of fewer marketing opportunities with our large financial institution marketing partners and reduced commissions principally from lower retail member volumes. Operating costs decreased primarily from lower product and servicing costs associated with the lower retail member volumes. General and administrative costs increased $16.1 million primarily due to the absence in 2013 of the reversal of a liability in 2012 of $14.6 million in connection with potential earn-out payments related to the Prospectiv acquisition.
Insurance and Package Products. Insurance and Package Products net revenues decreased by $9.3 million, or 10.8%, to $76.6 million for the three months ended March 31, 2013 as compared to $85.9 million for the three months ended March 31, 2012. Insurance revenue decreased approximately $6.9 million primarily from a higher cost of insurance resulting from higher claims experience. Package revenue decreased approximately $2.4 million primarily due to the impact of lower Package members.
Segment EBITDA decreased by $2.1 million, or 6.7%, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012, as the lower net revenues were partially offset by lower marketing and commissions.
Loyalty Products. Revenues from Loyalty Products increased by $4.3 million, or 11.2%, for the three months ended March 31, 2013 to $42.7 million as compared to $38.4 million for the three months ended March 31, 2012 primarily due to growth with existing clients.
Segment EBITDA increased by $4.3 million, or 34.7%, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 primarily due to the higher net revenue.
32
Table of Contents
Affinion International
International Products. International Products net revenues increased by $14.7 million, or 20.9%, to $84.9 million for the three months ended March 31, 2013 as compared to $70.2 million for the three months ended March 31, 2012. Net revenues increased primarily due to higher retail membership revenue associated with increased members along with revenues from our recently acquired concierge business in Turkey. The increase in net revenues was partially offset by $0.2 million from the unfavorable impact of the stronger U.S. dollar.
Segment EBITDA increased by $4.6 million, for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 as the higher revenue was partially offset by higher marketing and commissions, operating and general and administrative expenses primarily from higher product and servicing costs related to the increased membership base.
Corporate
Corporate costs increased by $0.8 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 as an unfavorable impact in foreign exchange on intercompany borrowings was partially offset by lower stock compensation costs in 2013 as compared to 2012.
Financial Condition, Liquidity and Capital Resources
Financial Condition—March 31, 2012 and December 31, 2012
March 31, 2013 | December 31, 2012 | Increase (Decrease) | ||||||||||
(in millions) | ||||||||||||
Total assets | $ | 1,489.8 | $ | 1,496.6 | $ | (6.8 | ) | |||||
Total liabilities | 2,917.6 | 2,909.1 | 8.5 | |||||||||
Total deficit | (1,427.8 | ) | (1,412.5 | ) | (15.3 | ) |
Total assets decreased by $6.8 million principally due to (i) a decrease in other intangibles, net of $19.0 million, principally due to amortization expense of $19.1 million and (ii) a decrease in other non-current assets of $9.1 million, principally due a decrease in an asset related to uncertain tax positions. These decreases, and other less significant decreases, were partially offset by an increase in cash of $30.6 million (see “—Liquidity and Capital Resources—Cash Flows
Total liabilities increased by $8.5 million, primarily due to an increase in accounts payable and accrued expenses of $23.2 million principally due to an increase in accrued interest resulting from the timing of interest payments. This increase was partially offset by an a decrease in deferred revenue of $5.1 million due to the continuing shift of the membership base to monthly memberships.
Total deficit increased by $15.3 million, principally due to a net loss attributable to the Company of $14.5 million and foreign currency translation effect of $1.6 million, partially offset by share-based compensation of $1.0 million.
Liquidity and Capital Resources
Our primary sources of liquidity on both a short-term and long-term basis are cash on hand and cash generated through operating and financing activities. Our primary cash needs are to service our indebtedness and for working capital, capital expenditures and general corporate purposes. Many of the Company’s significant costs are variable in nature, including marketing and commissions. The Company has a great degree of flexibility in the amount and timing of marketing expenditures and focuses its marketing expenditures on its most profitable marketing opportunities. Commissions correspond directly with revenue generated and have been decreasing as a percentage of revenue over the last several years. We believe that, based on our current operations and anticipated growth, our cash on hand, cash flows from operating activities and borrowing availability under Affinion’s revolving credit facility will be sufficient to meet our liquidity needs for the next twelve months and in the foreseeable future including quarterly amortization payments on Affinion’s term loan facility under Affinion’s $1.3 billion amended and restated senior secured credit facility. The term loan facility also requires mandatory prepayments based on excess cash flows as defined in Affinion’s amended and restated senior secured credit facility.
Affinion Holdings is a holding company, with no direct operations and no significant assets other than the ownership of 100% of the stock of Affinion. Because we conduct our operations through our subsidiaries, our cash flows and our ability to service our indebtedness is dependent upon cash dividends and distributions or other transfers from our subsidiaries. The terms of Affinion’s amended and restated senior secured credit facility and the indentures governing the Affinion senior notes and the Affinion senior subordinated notes significantly restrict our subsidiaries from paying dividends and otherwise transferring assets to us. The terms of each of these debt instruments provide Affinion with “baskets” that can be used to make certain types of “restricted payments,”
33
Table of Contents
including dividends or other distributions to us. If Affinion does not have sufficient payment capacity in the baskets with respect to its existing debt agreements in order to make payments to us, we may be unable to service the Affinion Holdings notes. During the three months ended March 31, 2013 and 2012, Affinion did not pay any cash dividends to us.
Although we historically have a working capital deficit, a major factor included in this deficit is deferred revenue resulting from the cash collected from annual memberships that is deferred until the appropriate refund period has concluded. In spite of our historical working capital deficit, we have been able to operate effectively primarily due to our substantial cash flows from operations and our available revolving credit facility. However, as the membership base continues to shift away from memberships billed annually to memberships billed monthly, it will have a negative effect on our operating cash flow. We anticipate that our working capital deficit will continue for the foreseeable future.
Cash Flows—Three Months Ended March 31, 2013 and 2012
At March 31, 2013, we had $82.5 million of cash and cash equivalents on hand, a decrease of $34.5 million from $117.0 million at March 31, 2012. The following table summarizes our cash flows and compares changes in our cash and cash equivalents on hand to the same period in the prior year.
Three Months Ended March 31, | ||||||||||||
2013 | 2012 | Change | ||||||||||
(in millions) | ||||||||||||
Cash provided by (used in): | ||||||||||||
Operating activities | $ | 44.6 | $ | 28.5 | $ | 16.1 | ||||||
Investing activities | (9.8 | ) | (15.8 | ) | 6.0 | |||||||
Financing activities | (3.0 | ) | (2.9 | ) | (0.1 | ) | ||||||
Effect of exchange rate changes | (1.2 | ) | 0.8 | (2.0 | ) | |||||||
|
|
|
|
|
| |||||||
Net change in cash and cash equivalents | $ | 30.6 | $ | 10.6 | $ | 20.0 | ||||||
|
|
|
|
|
|
Operating Activities
During the three months ended March 31, 2013, we generated $16.0 million more cash from operating activities than during the three months ended March 31, 2012. Segment EBITDA decreased by $15.5 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 (see “—Results of Operations”). During the three months ended March 31, 2013, receivables generated cash flows that were $11.6 million more favorable than the cash flows during the three months ended March 31, 2012 due to the timing of receipts for gift card funding and membership receivables of our Loyalty products and Membership products businesses, respectively, partially offset by the impact of seasonality of the travel business. This was partially offset by cash flows for the three months ended March 31, 2013 related to accounts payable and accrued expenses that were $10.7 million less favorable than the cash flows during the three months ended March 31, 2012 due to the timing of commission payments during the three months ended March 31, 2013 compared to the three months ended March 31, 2012 as well as the impact during the three months ended March 31, 2012 of the growth in our identity theft protection product, partially offset by the effect of the change in payment terms with a major Loyalty products client.
Investing Activities
We used $6.0 million less cash in investing activities during the three months ended March 31, 2013 as compared to the same period in 2012. During the three months ended March 31, 2013, we used $8.8 million for capital expenditures and $0.9 million for acquisition-related payments. During the three months ended March 31, 2012, we used $14.7 million for capital expenditures and $1.2 million for acquisition-related payments.
Financing Activities
We used $0.1 million more cash in financing activities during the three months ended March 31, 2013 as compared to the same period in 2012. During the three months ended March 31, 2013 and 2012, we made principal payments on our debt of $3.0 million and $2.9 million, respectively.
Credit Facilities and Long-Term Debt
As a result of the Apollo Transactions, we became a highly leveraged company and we have incurred additional indebtedness and refinancing indebtedness since the Apollo Transactions. We borrowed an additional $350.0 million ($346.5 million, net of discounts) under an unsecured term loan facility (the “unsecured term loan facility”) in January 2007. In October 2010, we sold $325.0 million aggregate principal amount of Affinion Holdings senior notes, and used a portion of the proceeds and cash on hand to repay the unsecured term loan facility. In addition, Affinion, our wholly owned subsidiary, entered into an amended and restated
34
Table of Contents
senior secured credit facility comprised of an $875.0 million term loan and a $125.0 million revolving credit facility in April 2010. In December 2010, Affinion entered into an agreement with two of its lenders resulting in an increase in the revolving credit facility to $165.0 million. In February 2011, Affinion incurred incremental borrowings of $250.0 million under its term loan facility. As of March 31, 2013, we had approximately $2.2 billion in indebtedness. Payments required to service this indebtedness have substantially increased our liquidity requirements as compared to prior years.
As part of the Apollo Transactions, Affinion, our wholly owned subsidiary, (a) issued $270.0 million principal amount of 10 1/8% senior notes due October 15, 2013 ($266.4 million net of discount) on October 17, 2005 and an additional $34.0 million aggregate principal amount of follow on senior notes on May 3, 2006 (collectively, the “senior notes”), (b) entered into a senior secured credit facility, consisting of a term loan facility in the principal amount of $860.0 million (which amount does not reflect the $231.0 million in principal prepayments that Affinion made prior to amendment and restatement of the senior secured credit facility in April, 2010) and a revolving credit facility in an aggregate amount of up to $100.0 million and (c) entered into a senior subordinated bridge loan facility in the principal amount of $383.6 million.
On June 5, 2009, Affinion issued $150.0 million aggregate principal amount ($136.5 million, net of discounts) of new senior notes (the “2009 senior notes,” and together with the 2005 senior notes, the “Affinion 10 1/8% senior notes”) in June 2009 for net proceeds of $136.5 million in a private placement transaction. As described below, the 2005 senior notes and the 2009 senior notes were repaid in the fourth quarter of 2010 and are no longer outstanding.
Affinion’s senior subordinated bridge loan facility was refinanced with the proceeds from the offering of senior subordinated notes (as defined below) and follow on senior notes. On April 26, 2006, Affinion issued $355.5 million aggregate principal amount of 11 1/2% senior subordinated notes due October 15, 2015 (the “Affinion senior subordinated notes”) and applied the gross proceeds of $350.5 million to repay $349.5 million of outstanding borrowings under Affinion’s senior subordinated loan facility, plus accrued interest, and used cash on hand to pay fees and expenses associated with such issuance. The interest on the Affinion senior subordinated notes is payable semi-annually. Affinion may redeem some or all of the Affinion senior subordinated notes at the redemption prices (generally at a premium) set forth in the agreement governing the senior subordinated notes. The Affinion senior subordinated notes are unsecured obligations. The senior subordinated notes are guaranteed by the same subsidiaries that guarantee the Affinion senior secured credit facility and the Affinion senior notes. The Affinion senior subordinated notes contain restrictive covenants related primarily to Affinion’s ability to distribute dividends to us, redeem or repurchase capital stock, sell assets, issue additional debt or merge with or acquire other companies.
On January 31, 2007, we entered into a five-year $350.0 million senior unsecured term loan with certain banks at an initial interest rate of LIBOR, as defined, plus 6.25% (the “Senior Unsecured Term Loan”). In October 2010, the senior unsecured term loan was repaid utilizing the proceeds from the Affinion Holdings senior notes (see below).
On April 9, 2010, Affinion, as Borrower, and Affinion Holdings, as a guarantor, entered into a $1.0 billion amended and restated senior secured credit facility with its lenders, amending its senior secured credit facility. We refer to Affinion’s amended and restated senior secured credit facility, as amended from time to time, including by the Incremental Assumption Agreements (as defined below) as “Affinion’s senior secured credit facility.” Affinion’s senior secured credit facility initially consisted of a five-year $125.0 million revolving credit facility and an $875.0 million term loan facility.
On October 5, 2010, the Company issued $325.0 million aggregate principal amount of 11.625% senior notes due November 2015 (the “Affinion Holdings senior notes”). The interest on the Affinion Holdings senior notes is payable semi-annually on May 15 and November 15 of each year. At any time prior to November 15, 2012, the Company could have redeemed the Affinion Holdings senior notes, at its option, in whole or in part, at a redemption price equal to the principal amount plus an applicable premium. On or after November 15, 2012, the Company may redeem some or all of the Affinion Holdings senior notes at any time at the redemption prices (generally at a premium) set forth in the indenture governing the Notes. The Affinion Holdings senior notes contain restrictive covenants related primarily to the Company’s ability to pay dividends, redeem or repurchase capital stock, sell assets, issue additional debt or merge with or acquire other companies. The Company used a portion of the net proceeds of $320.3 million, along with proceeds from a cash dividend from Affinion in the amount of $115.3 million, to repay the Senior Unsecured Term Loan. A portion of the remaining proceeds from the offering of the Affinion Holdings senior notes were utilized to pay related fees and expenses, with the balance retained for general corporate purposes. The fees and expenses were capitalized and are being amortized over the term of the Affinion Holdings senior notes. On August 24, 2011, pursuant to the registration rights agreement entered into in connection with the issuance of the Affinion Holdings senior notes, the Company completed a registered exchange offer and exchanged all of the then-outstanding Affinion Holdings senior notes for a like principal amount of Affinion Holdings senior notes that have been registered under the Securities Act.
On December 13, 2010, Affinion, as borrower, Affinion Holdings and certain of Affinion’s subsidiaries entered into an Incremental Assumption Agreement with two of Affinion’s lenders (the “Revolver Incremental Assumption Agreement,” and together with the Term Loan Incremental Assumption Agreement, the “Incremental Assumption Agreements”) which resulted in an increase in the revolving credit facility from $125.0 million to $160.0 million, with a further increase to $165.0 million in January 2011. On February 11, 2011, Affinion, as borrower, and Affinion Holdings, and certain of Affinion’s subsidiaries entered into, and simultaneously closed under, the Term Loan Incremental Assumption Agreement, which resulted in an increase in the term loan
35
Table of Contents
facility from $875.0 million to $1.125 billion. On November 20, 2012, Affinion, as Borrower, and Affinion Holdings entered into an amendment to the Affinion Credit Facility, which (i) increased the margins on LIBOR loans from 3.50% to 5.00% and on base rate loans from 2.50% to 4.00%, (ii) replaced the financial covenant requiring the Company to maintain a maximum consolidated leverage ratio with a financial covenant requiring Affinion to maintain a maximum senior secured leverage ratio, and (iii) adjusted the ratios under the financial covenant requiring Affinion to maintain a minimum interest coverage ratio.
The revolving credit facility includes a letter of credit subfacility and a swingline loan subfacility. The term loan facility matures in October 2016. However, the term loan facility will mature on the date that is 91 days prior to the maturity of the Affinion senior subordinated notes unless, prior to that date, (a) the maturity for the Affinion senior subordinated notes is extended to a date that is at least 91 days after the maturity of the term loan or (b) the obligations under the Affinion senior subordinated notes are (i) repaid in full or (ii) refinanced, replaced or defeased in full with new loans and/or debt securities with maturity dates occurring after the maturity date of the term loan. The term loan facility provides for quarterly amortization payments totaling 1% per annum, with the balance payable upon the final maturity date. The term loan facility also requires mandatory prepayments of the outstanding term loans based on excess cash flow (as defined), if any, and the proceeds from certain specified transactions. The interest rates with respect to term loans and revolving loans under Affinion’s senior secured credit facility are based on, at Affinion’s option, (a) the higher of (i) adjusted LIBOR and (ii) 1.50%, in each case plus 5.00%, or (b) the highest of (i) Deutsche Bank Trust Company Americas’ prime rate, (ii) the Federal Funds Effective Rate plus 0.5% and (iii) 2.50%, in each case plus 4.00%. The effective interest rate on the term loan for the three months ended March 31, 2013 and 2012 was 6.5% and 5.0% per annum, respectively. Affinion’s obligations under its senior secured credit facility are, and Affinion’s obligations under any interest rate protection or other hedging arrangements entered into with a lender or any of its affiliates will be, guaranteed by Affinion Holdings and by each of Affinion’s existing and subsequently acquired or organized domestic subsidiaries, subject to certain exceptions. Affinion’s senior secured credit facility is secured to the extent legally permissible by substantially all the assets of (i) Affinion Holdings, which consists of a pledge of all Affinion’s capital stock and (ii) Affinion and the subsidiary guarantors, including but not limited to: (a) a pledge of substantially all capital stock held by Affinion or any subsidiary guarantor and (b) security interests in substantially all tangible and intangible assets of Affinion and each subsidiary guarantor, subject to certain exceptions. Affinion’s senior secured credit facility also contains financial, affirmative and negative covenants. The negative covenants in Affinion’s senior secured credit facility include, among other things, limitations (all of which are subject to certain exceptions) on Affinion’s (and in certain cases, Affinion Holdings’) ability to declare dividends and make other distributions, redeem or repurchase its capital stock; prepay, redeem or repurchase certain of Affinion’s subordinated indebtedness; make loans or investments (including acquisitions); incur additional indebtedness (subject to certain exceptions); enter into agreements that would restrict the ability of Affinion’s subsidiaries to pay dividends; merge or enter into acquisitions; sell Affinion’s assets; and enter into transactions with its affiliates. Affinion’s senior secured credit facility also requires Affinion to comply with financial maintenance covenants with a maximum ratio of senior secured debt (as defined in Affinion’s senior secured credit facility) to EBITDA (as defined in Affinion’s senior secured credit facility) and a minimum ratio of EBITDA to cash interest expense. A portion of the proceeds of the term loan under Affinion’s senior secured credit facility were utilized to repay the outstanding balance of its existing senior secured term loan, including accrued interest, of $629.7 million and pay fees and expenses of approximately $27.0 million. Any borrowings under the revolving credit facility are available to fund Affinion’s working capital requirements, capital expenditures and for other general corporate purposes.
In January 2011, we utilized available cash on hand and the proceeds of a dividend from Affinion to (i) redeem our outstanding preferred stock with a liquidation preference of approximately $41.2 million, (ii) pay a dividend to our stockholders (including holders of restricted stock units) of $1.35 per share (approximately $115.4 million in the aggregate), (iii) pay a one-time cash bonus to our option holders of approximately $9.6 million and (iv) pay additional amounts for transaction fees and expenses.
In February 2011, Affinion used a portion of the Incremental Term Loans to pay a dividend to us of approximately $199.8 million. We used the proceeds of the dividend to (i) redeem our outstanding preferred stock with a liquidation preference of approximately $5.4 million, (ii) pay a dividend to our stockholders (including holders of restricted stock units) of $1.50 per share (approximately $128.2 million in the aggregate), (iii) pay a one-time cash bonus to certain of our option holders of approximately $5.2 million and (iv) pay additional amounts for transaction fees and expenses.
On November 19, 2010, Affinion completed a private offering of $475.0 million aggregate principal amount of 7.875% senior notes due 2018 (the “Affinion senior notes”) providing net proceeds of $471.5 million. The Affinion senior notes bear interest at 7.875% per annum payable semi-annually on June 15 and December 15 of each year, commencing on June 15, 2011. The Affinion senior notes will mature on December 15, 2018. The Affinion senior notes are redeemable at Affinion’s option prior to maturity. The indenture governing the Affinion senior notes contains negative covenants which restrict the ability of Affinion and its restricted subsidiaries to engage in certain transactions and also contains customary events of default. Affinion’s obligations under the Affinion senior notes are jointly and severally and fully and unconditionally guaranteed on a senior unsecured basis by each of Affinion’s existing and future domestic subsidiaries that guarantee Affinion’s indebtedness under the Affinion Group senior secured credit facility. The Affinion senior notes and guarantees thereof are senior unsecured obligations of Affinion and rank equally with all of Affinion’s and the guarantors’ existing and future senior indebtedness and senior to Affinion’s and the guarantors’ existing and future subordinated indebtedness. The Affinion senior notes are therefore effectively subordinated to Affinion’s and the guarantors’ existing
36
Table of Contents
and future secured indebtedness, including Affinion’s obligations under the Affinion Group senior secured credit facility, to the extent of the value of the collateral securing such indebtedness. The 7.875% senior notes are structurally subordinated to all indebtedness and other obligations of each of Affinion’s existing and future subsidiaries that are not guarantors. On August 24, 2011, pursuant to the registration rights agreement entered into in connection with the issuance of the 7.875% senior notes, Affinion completed a registered exchange offer and exchanged all of the then-outstanding 7.875% senior notes for a like principal amount of 7.875% senior notes that have been registered under the Securities Act. Affinion used substantially all of the net proceeds of the offering of the 7.875% senior notes to finance the purchase of the 2005 senior notes and the 2009 senior notes.
At March 31, 2013, the Company had $1,093.1 million outstanding under Affinion’s term loan facility, $325.0 million ($322.6 million, net of discount) outstanding under the Affinion Holdings senior notes, $475.0 million ($472.5 million, net of discount) outstanding under the Affinion senior notes and $355.5 million ($354.2 million, net of discount) outstanding under the Affinion senior subordinated notes. At March 31, 2013, there were no outstanding borrowings under Affinion’s revolving credit facility and Affinion had $151.8 million available under the revolving credit facility under Affinion’s senior secured credit facility, after giving effect to the issuance of $13.2 million of letters of credit.
Affinion’s senior secured credit facility and the indentures governing the Affinion senior notes and the Affinion senior subordinated notes contain various restrictive covenants that apply to Affinion. As of March 31, 2013, Affinion was in compliance with the restrictive covenants under Affinion’s debt agreements.
Covenant Compliance
The indenture governing the Affinion Holdings senior notes, among other things: (a) limits our ability and the ability of our subsidiaries to incur additional indebtedness, incur liens, pay dividends or make certain other restricted payments and enter into certain transactions with affiliates; (b) limits our ability to enter into agreements that would restrict the ability of our subsidiaries to pay dividends or make certain payments to us; and (c) places restrictions on our ability and the ability of our subsidiaries to merge or consolidate with any other person or sell, assign, transfer, convey or otherwise dispose of all or substantially all of our assets. However, all of these covenants are subject to significant exceptions. As of March 31, 2013, the Company was in compliance with the restrictive covenants under its debt agreements and expects to be in compliance over the next twelve months.
Affinion Holdings has the ability to incur additional debt, subject to limitations imposed by the indenture governing the Affinion Holdings senior notes. Under the indenture governing the Affinion Holdings senior notes, in addition to specified permitted indebtedness, Affinion Holdings will be able to incur additional indebtedness on an unconsolidated basis as long as on a pro forma basis our fixed charge coverage ratio (the ratio of Adjusted EBITDA to consolidated fixed charges) is at least 2.0 to 1.0.
Reconciliation of Non-GAAP Financial Measures to GAAP Financial Measures
Adjusted EBITDA consists of income from operations before depreciation and amortization further adjusted to exclude non-cash and unusual items and other adjustments permitted in our debt agreements to test the permissibility of certain types of transactions, including debt incurrence. We believe that the inclusion of Adjusted EBITDA is appropriate as a liquidity measure. Adjusted EBITDA is not a measurement of liquidity or financial performance under U.S. GAAP and Adjusted EBITDA may not be comparable to similarly titled measures of other companies. You should not consider Adjusted EBITDA as an alternative to cash flows from operating activities determined in accordance with U.S. GAAP, as an indicator of cash flows, as a measure of liquidity, as an alternative to operating or net income determined in accordance with U.S. GAAP or as an indicator of operating performance.
Set forth below is a reconciliation of our consolidated net cash provided by operating activities for the twelve months ended March 31, 2013 to Adjusted EBITDA as required by the indenture governing the Affinion Holdings senior notes.
Twelve Months Ended March 31, 2013(a) | ||||
(in millions) | ||||
Net cash provided by operating activities | $ | 47.2 | ||
Interest expense, net | 193.5 | |||
Income tax expense | 12.6 | |||
Amortization of debt discount and financing costs | (11.4 | ) | ||
Unrealized loss on interest rate swaps | (0.3 | ) | ||
Provision for loss on accounts receivable | (6.9 | ) | ||
Deferred income taxes | (4.6 | ) | ||
Changes in assets and liabilities | 50.1 | |||
Effect of purchase accounting, reorganizations, certain legal costs and net cost savings(b) | 28.8 | |||
Other, net(c) | 28.9 | |||
|
| |||
Adjusted EBITDA, excluding pro forma adjustments(d) | 337.9 | |||
Effect of the pro forma adjustments(e) | 2.9 | |||
|
| |||
Adjusted EBITDA, including pro forma adjustments(f) | $ | 340.8 | ||
|
|
37
Table of Contents
(a) | Represents consolidated financial data for the year ended December 31, 2012, minus consolidated financial data for the three months ended March 31, 2012, plus consolidated financial data for the three months ended March 31, 2013. |
(b) | Eliminates the effect of purchase accounting related to the Apollo Transactions and Back-Up and Travel acquisition, legal costs for certain legal matters and costs associated with severance incurred. |
(c) | Eliminates (i) net changes in certain reserves, (ii) foreign currency gains and losses related to unusual, non-recurring intercompany transactions, (iii) the loss from an investment accounted for under the equity method, (iv) costs associated with certain strategic and corporate development activities and (v) consulting fees paid to Apollo. |
(d) | Adjusted EBITDA, excluding pro forma adjustments, does not give pro forma effect to the projected annualized benefits of restructurings and other cost savings initiatives in connection with the Prospectiv and Back-Up and Travel acquisitions. However, we do make such accretive pro forma adjustments as if such restructurings and cost savings initiatives had occurred on April 1, 2012 in calculating the Adjusted EBITDA under Affinion’s amended and restated senior secured credit facility and the indentures governing Affinion’s 7.875% senior notes and senior subordinated notes and the Affinion Holdings senior notes. |
(e) | Gives effect to the projected annualized benefits of restructurings and other cost savings initiatives in connection with the Prospectiv and Back-Up and Travel acquisitions as if such restructurings and cost savings initiatives had occurred on April 1, 2012. |
(f) | Adjusted EBITDA, including pro forma adjustments, gives pro forma effect to the adjustments discussed in (e) above. |
Set forth below is a reconciliation of our consolidated net loss attributable to Affinion Group Holdings, Inc. for the twelve months ended March 31, 2013 to Adjusted EBITDA as required by our indenture governing the Affinion Holdings senior notes.
Twelve Months Ended March 31, 2013(a) | ||||
(in millions) | ||||
Net loss attributable to Affinion Group Holdings, Inc. | $ | (140.7 | ) | |
Interest expense, net | 193.5 | |||
Income tax expense | 12.6 | |||
Non-controlling interest | 0.4 | |||
Other expense, net | 0.2 | |||
Depreciation and amortization | 164.0 | |||
Effect of purchase accounting, reorganizations and non-recurring revenues and gains(b) | 1.7 | |||
Certain legal costs(c) | 12.7 | |||
Net cost savings(d) | 14.4 | |||
Other, net(e) | 79.1 | |||
|
| |||
Adjusted EBITDA, excluding pro forma adjustments(f) | 337.9 | |||
Effect of the pro forma adjustments(g) | 2.9 | |||
|
| |||
Adjusted EBITDA, including pro forma adjustments(h) | $ | 340.8 | ||
|
|
(a) | Represents consolidated financial data for the year ended December 31, 2012, minus consolidated financial data for the three months ended March 31, 2012, plus consolidated financial data for the three months ended March 31, 2013. |
(b) | Eliminates the effect of purchase accounting related to the Apollo Transactions and Back-Up and Travel acquisition. |
(c) | Represents the elimination of legal costs for certain legal matters. |
(d) | Represents the elimination of costs associated with severance incurred. |
(e) | Eliminates (i) net changes in certain reserves, (ii) share-based compensation expense, including payments to option holders, (iii) foreign currency gains and losses related to unusual, non-recurring intercompany transactions, (iv) the loss from an |
38
Table of Contents
investment accounted for under the equity method, (v) costs associated with certain strategic and corporate development activities, (vi) consulting fees paid to Apollo, (vii) facility exit costs and (viii) the impairment charge related to the goodwill and certain intangible assets of Prospectiv. |
(f) | Adjusted EBITDA, excluding pro forma adjustments, does not give pro forma effect to the projected annualized benefits of restructurings and other cost savings initiatives in connection with the Prospectiv and Back-Up and Travel acquisitions. However, we do make such accretive pro forma adjustments as if such restructurings and cost savings initiatives had occurred on April 1, 2012 in calculating the Adjusted EBITDA under Affinion’s amended and restated senior secured credit facility and the indentures governing Affinion’s 7.875% senior notes and senior subordinated notes and the Affinion Holdings senior notes. |
(g) | Gives effect to the projected annualized benefits of restructurings and other cost savings initiatives in connection with the Prospectiv and Back-Up and Travel acquisitions as if such restructurings and cost savings initiatives had occurred on April 1, 2012. |
(h) | Adjusted EBITDA, including pro forma adjustments, gives pro forma effect to the adjustments discussed in (g) above. |
Debt Repurchases
We or our affiliates have, in the past, and may, from time to time in the future, purchase any of Affinion Holdings’ or Affinion’s indebtedness. Any such future purchases may be made through open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices as we or any such affiliates may determine.
Critical Accounting Policies
In presenting our unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, we are required to make estimates and assumptions that affect the amounts reported therein. We believe that the estimates, assumptions and judgments involved in the accounting policies related to revenue recognition, accounting for marketing costs, stock-based compensation, valuation of goodwill and intangible assets, valuation of interest rate swaps and valuation of tax assets and liabilities could potentially affect our reported results and as such, we consider these to be our critical accounting policies. Several of the estimates and assumptions we are required to make relate to matters that are inherently uncertain, as they pertain to future events. However, certain events outside our control cannot be predicted and, as such, they cannot be contemplated in evaluating such estimates and assumptions. We believe that the estimates and assumptions used when preparing our unaudited condensed consolidated financial statements were the most appropriate at the time. Significant estimates include accounting for profit sharing receivables from insurance carriers, accruals and income tax valuation allowances, litigation accruals, the estimated fair value of stock based compensation, estimated fair values of assets and liabilities acquired in business combinations and estimated fair values of financial instruments. In addition, we refer you to our audited consolidated financial statements as of December 31, 2012 and 2011, and for the years ended December 31, 2012, 2011 and 2010, included in our Form 10-K for a summary of our significant accounting policies.
Item 3. | Quantitative and Qualitative Disclosures about Market Risk. |
We do not use derivative instruments for trading or speculative purposes.
Interest Rate Swap
In January 2009, Affinion entered into an interest rate swap effective February 21, 2011. The swap had a notional amount of $500.0 million and terminated on October 17, 2012. Under the swap, Affinion agreed to pay a fixed rate of interest of 2.985% in exchange for receiving floating payments based on a three-month LIBOR on the notional amount for each applicable period.
The interest rate swap was recorded at fair value, either as an asset or liability. The change in the fair value of the swap, which was not designated as a hedging instrument, is included in interest expense in the accompanying condensed consolidated statement of comprehensive income for the three months ended March 31, 2012.
The following table provides information about the Company’s financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity for the Company’s long-term debt as of March 31, 2013 (dollars are in millions unless otherwise indicated):
2013 | 2014 | 2015 | 2016 | 2017 | 2018 and Thereafter | Total | Fair Value At March 31, 2013 | |||||||||||||||||||||||||
Fixed rate debt | $ | 0.4 | $ | 0.4 | $ | 680.8 | $ | $ | $ | 475.0 | $ | 1,156.6 | $ | 893.4 | ||||||||||||||||||
Average interest rate | 10.04 | % | 10.04 | % | 10.04 | % | 7.88 | % | 7.88 | % | 7.88 | % | ||||||||||||||||||||
Variable rate debt | $ | 8.4 | $ | 11.3 | $ | 11.2 | $ | 1,062.2 | $ | 1,093.1 | $ | 1,074.0 | ||||||||||||||||||||
Average interest rate(a) | 6.50 | % | 6.50 | % | 6.50 | % | 6.50 | % |
(a) | Average interest rate is based on rates in effect at March 31, 2013. |
39
Table of Contents
Foreign Currency Forward Contracts
On a limited basis the Company has entered into 30 day foreign currency forward contracts, and upon expiration of the contracts, entered into successive 30 day foreign currency forward contracts. The contracts have been entered into to mitigate the Company’s foreign currency exposures related to intercompany loans which are not expected to be repaid within the next twelve months and that are denominated in Euros and British pounds. At March 31, 2013, the Company had in place contracts to sell EUR 26.6 million and receive $33.9 million and to sell GBP 13.9 million and receive $21.0 million.
During the three months ended March 31, 2013 and 2012, the Company recognized a realized gain of $2.6 million and a realized loss of $0.3 million, respectively. The Company had an unrealized loss of $0.2 million as of March 31, 2013.
At March 31, 2013, the Company’s estimated fair values of its foreign currency forward contracts are based upon available market information. The fair value of a foreign currency forward contract is based on significant other observable inputs, adjusted for contract restrictions and other terms specific to the foreign currency forward contracts. The fair values have been determined after consideration of foreign currency exchange rates and the creditworthiness of the party to each foreign currency forward contract. The counterparty to each foreign currency forward contract is a major financial institution. The Company does not expect any losses from non-performance by counterparties.
Credit Risk and Exposure
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of receivables, profit-sharing receivables from insurance carriers and prepaid commissions. We manage such risk by evaluating the financial position and creditworthiness of such counterparties. As of March 31, 2013, approximately $62.6 million of the profit-sharing receivable was due from one insurance carrier. Receivables and profit-sharing receivables from insurance carriers are from various marketing, insurance and business partners and we maintain an allowance for losses, based upon expected collectability. Commission advances are periodically evaluated as to recovery.
Item 4. | Controls and Procedures. |
Evaluation of Disclosure Control and Procedures. The Company, under the direction of the Chief Executive Officer and the Chief Financial Officer, has established disclosure controls and procedures (“Disclosure Controls”) that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. The Disclosure Controls are also intended to ensure that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our Disclosure Controls or our “internal controls over financial reporting” (“Internal Controls”) will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Notwithstanding the foregoing, our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives.
As of March 31, 2013, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that as of March 31, 2013, the Company’s disclosure controls and procedures are effective at the reasonable assurance level.
40
Table of Contents
Changes in Internal Control over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
41
Table of Contents
Item 1. | Legal Proceeding. |
Information required by this Item is contained in Note 7 to our unaudited condensed consolidated financial statements within Part I of this Form 10-Q.
Item 1A. | Risk Factors |
There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.
Item 2. | Unregistered Sales of Equity in Securities and Use of Proceeds. |
None.
Item 3. | Defaults Upon Senior Securities. |
None.
Item 4. | Mine Safety Disclosure. |
Not applicable.
Item 5. | Other Information. |
None.
Item 6. | Exhibits. |
Exhibit Number | Description | |
31.1* | Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a). | |
31.2* | Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a). | |
32.1** | Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. | |
32.2** | Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. | |
101.INS XBRL† | Instance Document | |
101.SCH XBRL† | Taxonomy Extension Schema | |
101.CAL XBRL† | Taxonomy Extension Calculation Linkbase | |
101.DEF XBRL† | Taxonomy Extension Definition Linkbase | |
101.LAB XBRL† | Taxonomy Extension Label Linkbase | |
101.PRE XBRL† | Taxonomy Extension Presentation Linkbase |
* | Filed herewith. |
** | Furnished herewith. |
† | Pursuant to applicable securities laws and regulations, the Company is deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and is not subject to liability under any anti-fraud provisions of the federal securities laws as long as the Company has made a good faith attempt to comply with the submission requirements and promptly amends the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised that, pursuant to Rule 406T, these interactive data files are deemed not filed and otherwise are not subject to liability. |
42
Table of Contents
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
AFFINION GROUP HOLDINGS, INC. | ||||||
Date: April 25, 2013 | By: | /S/ MARK G. GIBBENS | ||||
Mark G. Gibbens | ||||||
Executive Vice President and Chief Financial Officer |
S-1
Table of Contents
EXHIBIT INDEX
Exhibit Number | Description | |
31.1* | Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) or 15d-14(a). | |
31.2* | Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) or 15d-14(a). | |
32.1** | Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. | |
32.2** | Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. | |
101.INS XBRL† | Instance Document | |
101.SCH XBRL† | Taxonomy Extension Schema | |
101.CAL XBRL† | Taxonomy Extension Calculation Linkbase | |
101.DEF XBRL† | Taxonomy Extension Definition Linkbase | |
101.LAB XBRL† | Taxonomy Extension Label Linkbase | |
101.PRE XBRL† | Taxonomy Extension Presentation Linkbase |
* | Filed herewith. |
** | Furnished herewith. |
† | Pursuant to applicable securities laws and regulations, the Company is deemed to have complied with the reporting obligation relating to the submission of interactive data files in such exhibits and is not subject to liability under any anti-fraud provisions of the federal securities laws as long as the Company has made a good faith attempt to comply with the submission requirements and promptly amends the interactive data files after becoming aware that the interactive data files fail to comply with the submission requirements. Users of this data are advised that, pursuant to Rule 406T, these interactive data files are deemed not filed and otherwise are not subject to liability. |